I was approached by a younger friend for advice.  This is my response to his questions below:

Thank you for agreeing to do this for me. I would love to have an actual conversation with you but unfortunately, I think that between all of the classes, exams, and group project meetings I have this week it would prove to be too much of a hassle for both of us to try to set up a time.

1. What professional and soft skills do you need to be successful in this career and why?
2. What advice would you give to someone considering working in this field?
3. What are some values/ethics that have been important to you throughout your career?
4. I understand that you currently run a solo operation, but are there any leadership skills you have needed previously in your career? Any examples?
5. What made you decide to make the switch to running your own business?

Thanks again,

ZZZ

What professional and soft skills do you need to be successful in this career and why?

I’ve written at least two articles on this:

How Do I Find a Job in Finance?

How Do I Find a Job in Finance? (Part 2)

Let me answer the question more directly.  You need to understand the basics of how businesses operate.  How do they make money?  How do they control risk?

Now, the academics will show you their models, and you should know those models.  What is more important is understanding the weaknesses of those models because they may weakly explain how stocks in aggregate are priced, but they are little good at understanding how corporations operate.  The real world is not as ideal as the academic economists posit.

It is useful to read broadly.  It is useful to dig into a variety of financial reports from smaller firms.  Why smaller firms?  They are simpler to understand, and there is more variation in how they do.   Learn to read through the main financial statements well.  Understand how the income statement, balance sheet, and cash flow statement interact.  Look at the footnotes and try to understand what they mean.  Pick an industry and compare all of the companies.  I did that with trucking in 1994 and learned a boatload.  This aids in picking up practical accounting knowledge, which is more powerful when you can compare across industries.

As for soft skills, the ability to deal with people on a firm and fair basis is huge.  Keeping your word is big as well.  When I was a bond trader, I ate losses when I made promises on trades that went wrong.  In the present era, I have compensated clients for losses from mistaken trades.

Here’s another “soft” skill worth considering.  Many employers are aghast at the lousy writing skills of young people coming out of college, and rightly so.  Make sure that your ability to communicate in a written form is at a strong level.

Oral communication is also important.  If you have difficulty speaking to groups, you might try something like Toastmasters.

Many of these things come only with practice on the job, so don’t think that you have to have everything together in order to do well — the important thing is to improve over time.  Young people are not expected to be as polished as their older colleagues.

What advice would you give to someone considering working in this field?

It’s a little crowded in finance.  That is partially because it attracts a lot of people who think it will be easy money.  If you are really good, the crowding shouldn’t be much of a hurdle.  But if you don’t think that you are in the top quartile, there are some alternatives to help you grow and develop.

  • Consider developing your skills at a small bank or insurer.  You will be forced to be a generalist, which sets you up well for future jobs.  It also forces you to confront how difficult the economics of smaller firms are, and how costly/difficult it is to change strategy.  For a clever person, it offers a lot of running room if you work for a firm that is more entrepreneurial
  • Or, consider working in the finance area of an industrial firm.  Finance is not only about selling financial products — it is about the buyers as well.
  • Work for a government or quasi-governmental entity in their finance area.  If you can show some competence there, it would be notable.  The inefficiencies might give you good ideas for what could be a good business.

What are some values/ethics that have been important to you throughout your career?

Here are some:

  • Be honest
  • Follow laws and regulations
  • Work hard for your employer
  • Keep building your skills; at 57, I am still building my skills.
  • Don’t let work rob you of other facets of life — family, friends, etc.  Many become well-paid slaves of their organization, but never get to benefit personally outside of work.
  • Avoid being envious; just focus on promoting the good of the entity that you work for.
  • Try to analyze the culture of a firm before you join it.  Culture is the most important aspect that will affect how happy you are working there.

I understand that you currently run a solo operation, but are there any leadership skills you have needed previously in your career? Any examples?

This is a cute story: Learning Leadership.  I have also written three series of articles on how I grew in the firms that I worked for:

There’s a lot in these articles.  They are some of my best stories, and they help to illustrate corporate life.  Here’s one more: My 9/11 Experience.  What do you do under pressure?  What I did on 9/11 was a good example of that.

I know I have a lot more articles on the topic on this, but those are the easiest to find.

What made you decide to make the switch to running your own business?

I did very well in my own investing from 2000-2010, and wanted to try out my investing theories as a business.  That said, from 2011-2017, it worked out less well than I would have liked as value investing underperformed the market as a whole.

That said, I proceed from principle, and continue to follow my investment discipline.  It follows from good business management principles, and so I continue, waiting for the turn in the market cycle, and improving my ability to analyze corporations.

Nonetheless, my business does well, just not as well as I would like.

I hope you do well in your career.  Let me know how you do as you progress, and feel free to ask more questions.

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Dear Readers, this is another one of my occasional experiments, so please be measured in your comments.  The following was written as a ten-year retrospective article in 2042.

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It was indeed an ugly surprise to many when the payments from Social Security in February 2032 did not come.  Indeed, the phones in Congress rang off the hook, and the scroll rate on incoming emails broke all records.  But as with most things in DC in the 21st century, there was no stomach to deal with the problem, as gridlock continued to make Congress a internally hostile but essentially passive institution.

Part of that gridlock stemmed from earlier Congressional reforms that looked good at the time, but reduced the power of parties to discipline members who would not go along with the leadership.  Part also stemmed from changes in media, which were developing in the 1980s because the media was increasingly out of sync with the views of average Americans, but came to full fruition after the internet became the dominant channel for news flow, allowing people to tune out voices unpleasant to them.  Gerrymandering certainly did not help, as virtually all House seats were noncompetitive.  Finally, the size of the debt, and large continuing deficits limited the ability of the government to do anything.  The Fed was already letting inflation run at rates higher than intermediate interest rates, so they were out of play as well.

Despite occasional warnings in the media that began five years earlier after the Chief Actuary of the Social Security Administration suggested in his 2027 year-end report that this was likely to happen in 4-6 years, most media and people tuned it out because it was impossible in their eyes, and face it, actuaries are deadly dull people.  Only a few bloggers kept up a drumbeat on the topic, but they were ignored as Johnny One-Note Disasterniks.

Shortly thereafter, the obligatory hearings began in Congress, and the new Chief Actuary of the Social Security Administration was first on the list to testify.  First he explained that when the Social Security was developed, this safeguard was added in case the income and assets of the trust were inadequate to make the next payment, that payment would be skipped.  He added that by law, skipped payments would not be made up later.  After all, Social Security is an earned right, but mainly a statutory right and not a constitutional right.  Then he commented that without changes, a payment would likely be skipped in 2033 and 2034, two skips each in 2035 and 2036, and by 2037 three skips would be the “new normal” until demographics normalized, but that would likely take a generation to achieve, as childbearing was out of favor.

There were many other people who testified that day from AARP, its relatively new but strong foe AAWP (w -> Working), and various conservative and liberal think tanks, but no one said anything valuable that the Chief Actuary didn’t already say: without changes to benefits or taxes (contributions, haha), payment skipping would become regular.  It was a darkly amusing sidelight that members of the House of Representatives managed to trot out every “urban myth” about Social Security as true during their hearings, including the bogus idea that everyone has their contributions stored in the own little accounts.

The eventual compromise was not a pretty one:

  • Cost-of-living adjustments were ended.
  • Benefits were means-tested.
  • Late retirement adjustment factors were decreased.
  • All the games where benefits could be maximized were eliminated.
  • Immigration restrictions were loosened for well-off immigrants.
  • The normal retirement age was raised to 72, and
  • “Contributions” would now be assessed on income of all types, with no upper limit.  That said, the rate did not rise.

That ended the payment skipping, though it is possible that a skip could happen in the future.  As it is, much of the current political climate is marked by intergenerational conflict, with Social Security viewed derisively as an old-age welfare plan.  A visitor to the grave of FDR did not find him doing 2000 RPM, but did note the skunk cabbage that someone helpfully planted there.  As it was, quiet euthanasia, some voluntary, some not, took place among the elderly Baby Boomers, tired of being labelled sponges on society, or picked off by annoyed caretakers.

It should be noted that as benefits were cut in real terms, friends and families of the some elderly and disabled helped out, but many elderly people led lives of poverty.  Perhaps if they had expected this, they would have prepared, but they trusted the malleable promises of the US Government.

The open question at present is whether it was wise for society to promote collective security schemes.  As it is, with seven states in pseudo-bankruptcy, many municipalities in similar straits if not real bankruptcy, and many countries suffering with worse demographic problems than the US, the problems of these arrangements are apparent:

  • Breaking the link between childbearing and support in old age discouraged childbearing.
  • Every succeeding generation of participants got a worse deal than those that came before.
  • Politicians learned to prioritize the present over the future, and use monies that should have been put to some productive future use into the benefit of those who would consume currently.
  • Complexity encouraged gaming of the system, whether it was maxing benefits, or faking disability.
  • Retirement ages that were too low made the burden too heavy to the workers supporting retirees.

Future articles in this retrospective series will touch on some of the other problems we have recently faced, as many involuntary collective security measures have hit troubled times, and the unintended effects of too much debt, both governmental and private are still with us.

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Last week, there was an article in Barron’s describing how many mutual fund families take advantage of a provision in the law allowing them to have funds lend to one another.  Quoting from the article:

Under normal circumstances the Securities and Exchange Commission bars funds from making “affiliated transactions,” but there’s a loophole in the Investment Company Act of 1940 for funds to apply for an exemption to make such “interfund loans.” Until recently, few fund families applied for this exemption. None had before 1990. From 2006 to 2016, the SEC approved just 18 interfund lending applications. But since January 2016, the agency has approved 26. Most major fund families—BlackRock, Vanguard, Fidelity, Allianz—now can make such loans. Stiffer regulations of banks, which are now less willing to offer funds credit lines, partly explain the application surge.

I’m here tonight to suggest making a virtue out of necessity, because one day this practice will be banned after another crisis if something goes afoul.  Let the mutual fund companies that do this set up a special “crisis lending fund,” and put in place the following provisions:

  • The various funds that can borrow from the crisis lending fund must pay a commitment fee for the capital that could be lent.  Make it similar to what a bank provides on a revolving credit line.
  • When funds are not lent, it is invested in Treasury securities, or something of very high quality, in a five-year ladder.
  • When funds are lent, they receive a rate similar to rates current on single-B junk bonds.
  • The lending to other funds is secured, such that if the loans are collateralized by less than 200%, the loans must be paid down.  I.e., if the fund has $200 million of net asset value, there can be at most $100 million of loans, from all parties lending to the fund.

This would be an attractive, somewhat countercyclical asset for people to invest in.  Who wouldn’t want a fund that made additional money during a crisis, and was safe the rest of the time as well?

Just a stray thought.  As with many of my ideas, this would help create a stable private-sector solution where the government might otherwise intrude.

July 2017September 2017Comments
Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.No change.  Feels like GDP is slowing, though.
Job gains have been solid, on average, since the beginning of the year, and the unemployment rate has declined.Job gains have remained solid in recent months, and the unemployment rate has stayed low.Shades labor conditions down, as improvement has seemingly stopped.
Household spending and business fixed investment have continued to expand. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. Shades business fixed investment up.  Does that matter as much in an intangible economy?
On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent.On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined this year and are running below 2 percent.Small change of timing.  It’s not much below 2%…
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.No change
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.The Dual Mandate is the perfect shield to hide behind.  The Fed can be wrong, but it can never be blamed.
The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship. Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.Mentions the transitory effects of hurricanes.  Aside from that, they think they are on track.
Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.No change.  Note the unbalanced language, though – they are only monitoring inflation closely.
In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent.In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.No change, but monetary policy is no longer accommodative.  The short end of the forward curve continues to rise, and the curve flattens.
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.  If you don’t know what will drive decision-making, i.e., it could be anything, just say that.
The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.No change. Symmetric: we can’t let inflation get too low, because we don’t regulate banks properly.
The Committee expects that economic conditions will evolve in a manner that will warrant 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.The Committee expects that economic conditions will evolve in a manner that will warrant 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.No change
However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change
For the time being, 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.Deleted; QE is over (for now).
The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated; this program is described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.Promises the very slow end of QE, as they may start to let securities mature.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.No dissents; it’s relatively easy to agree with doing nothing.

 

Comments

  • Labor conditions can’t get much better. GDP is meandering.
  • The yield curve is flattening, with short rates rising more than long rates.
  • Stocks, bonds and gold fall a little. Though the statement doesn’t say it, many conclude that tightening will continue.
  • I think the Fed is too optimistic about the economy. I also think that they won’t get far into letting securities mature before they resume reinvestment.

Photo Credit: Fabio Tinelli Roncalli || Alas, there were so many signs that the avalanche was coming…

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Ten years ago, things were mostly quiet.  The crisis was staring us in the face, with a little more than a year before the effects of growing leverage and sloppy credit underwriting would hit in full.  But when there is a boom, almost no one wants to spoil the party.  Yes a few bears and financial writers may do so, but they get ignored by the broader media, the politicians, the regulators, the bulls, etc.

It’s not as if there weren’t some hints before this.  There were losses from subprime mortgages at HSBC.  New Century was bankrupt.  Two hedge funds at Bear Stearns, filled with some of the worst exposures to CDOs and subprime lending were wiped out.

And, for those watching the subprime lending markets the losses had been rising since late 2006.  I was following it for a firm that was considering doing the “big short” but could not figure out an effective way to do it in a way consistent with the culture and personnel of the firm.  We had discussions with a number of investment banks, and it seemed obvious that those on the short side of the trade would eventually win.  I even wrote an article on it at RealMoney in November 2006, but it is lost in the bowels of theStreet.com’s file system.

Some of the building blocks of the crisis were evident then:

  • European banks in search of any AAA-rated structured product bonds that had spreads over LIBOR.  They were even engaged in a variety of leverage schemes including leveraged AAA CMBS, and CPDOs.  When you don’t have to put up any capital against AAA assets, it is astounding the lengths that market players will go through to create and swallow such assets.  The European bank yield hogs were a main facilitator of the crisis that was to come, followed by the investment banks, and bullish mortgage hedge funds.  As Gary Gorton would later point out, real disasters happen when safe assets fail.
  • Speculation was rampant almost everywhere. (not just subprime)
  • Regulators were unwilling to clamp down on bad underwriting, and they had the power to do so, but were unwilling, as banks could choose their regulators, and the Fed didn’t care, and may have actively inhibited scrutiny.
  • Not only were subprime loans low in credit quality, but they had a second embedded risk in them, as they had a reset date where the interest rate would rise dramatically, that made the loans far shorter than the houses that they financed, meaning that the loans would disproportionately default near their reset dates.
  • The illiquidity of the securitized Subprime Residential Mortgage ABS highlighted the slowness of pricing signals, as matrix pricing was slow to pick up the decay in value, given the sparseness of trades.
  • By August 2007, it was obvious that residential real estate prices were falling across the US.  (I flagged the peak at RealMoney in October 2005, but this also is lost…)
  • Amid all of this, the “big short” was not a sure thing as those that entered into it had to feed the trade before it succeeded.  For many, if the crisis had delayed one more year, many taking on the “big short” would have lost.
  • A variety of levered market-neutral equity hedge funds were running into trouble in August 2007 as they all pursued similar Value plus Momentum strategies, and as some fund liquidated, a self reinforcing panic ensued.
  • Fannie and Freddie were too levered, and could not survive a continued fall in housing prices.  Same for AIG, and most investment banks.
  • Jumbo lending, Alt-A lending and traditional mortgage lending had the same problems as subprime, just in a smaller way — but there was so much more of them.
  • Oh, and don’t forget hidden leverage at the banks through ABCP conduits that were off balance sheet.
  • Dare we mention the Fed inverting the yield curve?

So by the time that BNP Paribas announced that three of their funds that bought Subprime Residential Mortgage ABS had pricing issues, and briefly closed off redemptions, and Countrywide announced that it had to “shore up its funding,” there were many things in play that would eventually lead to the crisis that happened.

Some of us saw it in part, and hoped that things would be better.  Fewer of us saw a lot of it, and took modest actions for protection.  I was in that bucket; I never thought it would be as large as it turned out.  Almost no one saw the whole thing coming, and those that did could not dream of the response of the central banks that would take much of the losses out of the pockets of savers, leaving bad lending institutions intact.

All in all, the crisis had a lot of red lights flashing in advance of its occurrence.  Though many things have been repaired, there are a lot of people whose lives were practically ruined by their own greed, and the greed of others.  It’s a sad story, but one that will hopefully make us more careful in the future when private leverage rises, creating an asset bubble.

But if I know mankind, the lesson will not be learned.

PS — this is what I wrote one decade ago.  You can see what I knew at the time — a lot of the above, but could not see how bad it would be.

Photo Credit: Leo Newball, Jr. || I visited that building when I was 24.

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June 2017July 2017Comments
Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.No change.  Feels like GDP is slowing, though.
Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined.Job gains have been solid, on average, since the beginning of the year, and the unemployment rate has declined.Shades labor conditions up
Household spending has picked up in recent months, and business fixed investment has continued to expand.Household spending and business fixed investment have continued to expand.No real change
On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent.On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent.Changes, but to little effect.
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.No change
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; somebody tell them that things that can’t change don’t belong here.
The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.No change; monetary policy solves all.
Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.No change.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent.In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.No change, but monetary policy is no longer accommodative.  The short end of the forward curve continues to rise, and the curve flattens.
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.  If you don’t know what will drive decision-making, i.e., it could be anything, just say that.
The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.No change. Symmetric: we can’t let inflation get too low, because we don’t regulate banks properly.
The Committee expects that economic conditions will evolve in a manner that will warrant 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.The Committee expects that economic conditions will evolve in a manner that will warrant 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.No change
However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change
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.For the time being, 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.No change
The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated;Accelerates the timing of change.
This program, which would gradually reduce the Federal Reserve’s securities holdings by decreasing reinvestment of principal payments from those securities, is described in the accompanying addendum to the Committee’s Policy Normalization Principles and Plans.this program is described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.Promises the slow end of QE, as they may start to let securities mature.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; and Jerome H. Powell.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.No dissents; it’s relatively easy to agree with doing nothing.
Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.No dissents.

 

Comments

  • Labor conditions are reasonably good. GDP is meandering.
  • The yield curve is flattening, with long rates falling.
  • Stocks, bonds and gold rise a little.
  • I think the Fed is too optimistic about the economy. I also think that they won’t get far into letting securities mature before they resume reinvestment of maturing bonds. [miswrote that last time]

 

May 2017June 2017Comments
Information received since the Federal Open Market Committee met in March indicates that the labor market has continued to strengthen even as growth in economic activity slowed.Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.Shades GDP up
Job gains were solid, on average, in recent months, and the unemployment rate declined.Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined.Shades labor conditions down
Household spending rose only modestly, but the fundamentals underpinning the continued growth of consumption remained solid.  Business fixed investment firmed.Household spending has picked up in recent months, and business fixed investment has continued to expand.Shades up household spending and business fixed investment
Inflation measured on a 12-month basis recently has been running close to the Committee’s 2 percent longer-run objective. Excluding energy and food, consumer prices declined in March and inflation continued to run somewhat below 2 percent.On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent.Shades inflation down.
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.No Change
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
The Committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term.The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.Inflation down, growth up
Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.Watches inflation closely, no longer looking at the rest of the world.
In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 3/4 to 1 percent.In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent.Raises the Fed funds target range 1/4 percent.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.No Change
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
The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.No Change
The Committee expects that economic conditions will evolve in a manner that will warrant 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.The Committee expects that economic conditions will evolve in a manner that will warrant 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.No Change
However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No Change
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,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.No Change
and it anticipates doing so until normalization of the level of the federal funds rate is well under way.The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.I guess the low 1% region is what is considered the low end of a normal federal funds rate.
This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.This program, which would gradually reduce the Federal Reserve’s securities holdings by decreasing reinvestment of principal payments from those securities, is described in the accompanying addendum to the Committee’s Policy Normalization Principles and Plans.Promises the slow end of QE, as they may start to let securities mature.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; and Jerome H. Powell.All but one follow through on the idea that tightening is needed.
Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.Kashkari is a quirky guy.  Who knows?  Maybe he notes the flattening yield curve.

 

Comments

  • Labor conditions are reasonably good. GDP might be improving.
  • The yield curve is flattening, with long rates falling.
  • Stocks and gold fall. Bonds rose this morning and remain up.
  • I think the Fed is too optimistic about the economy. I also think that they won’t get far into letting securities mature before they stop reinvestment.
  • Interesting that they dropped the statement about following global financial conditions.

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Stocks always return more than Treasury Bonds.  So why doesn’t Social Security invest the trust funds in stocks rather than Treasury bonds?

The first reason is simple.  The government wanted Social Security to be free from accusations of favoritism.  Why should public businesses have access to government capital, when private capital doesn’t have that same advantage?  The second reason is also simple: do we want the government to be an owner of a large percentage of the businesses of the country?  Do you want the government to have even more influence on businesses than activist investors do?

The third reason is complex.  Do you want to mess up the stock market?  A large dedicated buyer would drive the market up to levels where future returns would be very low, much lower than at present.  Very marginal businesses would go public to take advantage of the dumb capital.

Far from earning more money for Social Security, the investment would put in the top of the market.  There would be a generational top where the brightest investors would leave the market,,  Future returns would be low.

Not that anyone significant is suggesting it at present, but it is wiser to keep governments out of business management.  Don’t reach for false gains in investment performance if the price is government involvement in the details of business.

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One more note: all of the benefits of Social Security are based off of labor earnings, not capital earnings.  Most taxes are collected from labor income.  That’s why Treasury bonds make sense — it is a neutral asset that is similar to those who receive the benefits.  Treasury bonds are as broad-based as those who receive benefits.

Photo Credit: Norman Maddeaux

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February 2017March 2017Comments
Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace.Information received since the Federal Open Market Committee met in February indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace.No real change.
Job gains remained solid and the unemployment rate stayed near its recent low. Job gains remained solid and the unemployment rate was little changed in recent months. No real change.
Household spending has continued to rise moderately while business fixed investment has remained soft.Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat.Shades up business fixed investment.
Measures of consumer and business sentiment have improved of late. That sentence lasted for one statement.
Inflation increased in recent quarters but is still below the Committee’s 2 percent longer-run objective.Inflation has increased in recent quarters, moving close to the Committee’s 2 percent longer-run objective; excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent. Shades their view of inflation up.

Excluding two categories that have had high though variable inflation rates is bogus. Use a trimmed mean or the median.

Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.No change. What would be a high number, pray tell?  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.15%, unchanged from February.
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. But don’t blame the Fed, blame Congress.
The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will rise to 2 percent over the medium term.The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term.No real change.

CPI is at +2.8%, yoy.  Seems to be rising quickly.

Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.No change.
In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1/2 to 3/4 percent.In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent.Kicks the Fed Funds rate up ¼%.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.Suggests that they are waiting to see 2% inflation for a while before making changes.

They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.  Think of monetary policy as a drug for which a tolerance gets built up.

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 will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.Now that inflation is 2%, they have to decide how much they are willing to let it run before they tighten with vigor.
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.The Committee expects that economic conditions will evolve in a manner that will warrant 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.No change.  Says it will keep reinvesting maturing proceeds of treasury, 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; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Jerome H. Powell; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Daniel K. Tarullo.Large agreement.
 Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.Kashkari willing to be the lone dove amid rising inflation.  I wonder if he is thinking about systemic issues?

Comments

  • 2% inflation arrives, and the FOMC tightens another notch.
  • They are probably behind the curve.
  • The economy is growing well now, and in general, those who want to work can find work.
  • The change of the FOMC’s view is that inflation is higher. Equities and bonds rise. Commodity prices rise and the dollar weakens.
  • The FOMC says that any future change to policy is contingent on almost everything.

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I wrote this to summarize my thoughts from a chat session that I was able to participate in at Thompson Reuters Global Markets Forum yesterday.  It was wider ranging than this, but was a very enjoyable time.  Thanks to Manoj Rawal for inviting me.

On the Pursuit of Economic Growth

I think one of the conceits of the modern era is the degree of trust we place in governments.  We want them to do everything for us.  The truth is that their power is limited.  Even if we delegate more power to them, that doesn’t mean the power can/will be used by the government for the purposes intended.

The government is composed of people with their own goals.  It’s not much different than shareholders delegating power of the corporation to a board of directors, who collectively oversee management, should they care to do so.  Often delegated power gets misdirected for the ends of the power- and money-hungry.

Who watches the watchers?  It is one reason why we have “rule of law” in many republics – there is law that governs the government, if we have the will to maintain that.  It differs from “rule by law” which exists more commonly on Earth – laws exist so that the rulers can maintain their rule over those they rule – of which China is an excellent example.  Freedom that is good for the interests of the Communist Party is allowed to exist, but not other freedoms.  There are no rights that are God-given, not subject to the dictates of governments.

Sorry for the digression – my main point is that even the most powerful governments get bogged down, and can’t do nearly what people imagine they can do.  It is akin to what Peter Drucker said on management, that where managers proliferate, it takes progressive more people to manage all of the people – you might actually be able to get more done with fewer people.

Governments face another constraint – because people think the government can stimulate the economy, we have had governments stretch past their budgetary limits, borrow a lot of money, and make long-dated promises that they can’t keep.  This is not just a US phenomenon.  This is happening globally.  It is rare, possibly even non-existent to find countries that run balanced budgets, have sound monetary policy, and haven’t overpromised on entitlements.

As such, there isn’t that much that governments can do in terms of discretionary spending.  Even when they do allocate money, most projects of any significance don’t produce immediate results, but take years to start and more years to complete.  China may be able to run roughshod over its citizens, but where rule of law exists, there is necessary delay for most projects.  Obama or Trump can long for “shovel ready” projects.  They don’t exist, at least not many of them exist that are sizable.

As such, when I look at the plans of Donald Trump, I don’t give them a lot of weight in investment decisions that I make.  The same goes for any US or foreign leader, central banker, or whatever.  Short of starting a war, the amount of truly impactful things he can do is limited, especially for overly indebted governments.

What does matter then?  I think culture matters a lot.  Here are some questions to think about:

  • What priority do we place on taking risk?
  • How do you balance the competing needs of creditors and debtors?
  • How easy is it to start a business?
  • How do we feel about people using natural resources for profit?
  • How predictable is government policy, so that people can make long-term plans, and not worry about whether they will be able to see those plans to their fruition or not?
  • Does the culture protect private property?
  • Do we encourage men and women to marry, start families, and raise intelligent children?
  • Do we encourage charitable endeavors, so that effective help can be given to those who genuinely want to escape poverty? (rather than perpetuate it through continual handouts?)
  • How much do we play favorites across and within industries?
  • To what degree do we force uneconomic growth objectives through tax incentives, such as owning a home, rather than renting?
  • How much are we willing to allow technology to eliminate jobs, such that labor is directed away from simple tasks to tasks of higher complexity?

It is my opinion that those are the greater drivers of economic growth, and that the government can do little to foster growth, aside from having simple long-term policies, and letting us get on with being productive.

As such, I don’t see a lot going on right now that should promote higher growth.  Note that high growth is not necessary for a strong stock market, but it is necessary if you want to see ordinary laborers benefit in society.