Month: January 2010

Book Review: Wealth, War & Wisdom

Book Review: Wealth, War & Wisdom

Posted on by David Merkel

The first thing I do when a PR flack sends me a book is throw away their summary.? Unlike other reviewers, I read the books.? The publisher sent me this book, but I did not ask for it.

All that said, I thought Wealth, War & Wisdom was a great book, and I spent more time on it than I normally do for books of equivalent length.? Why?? It covered areas of history that I was not as aware of.

This book is really two books in one.? It is a book that covers the history of WWII in an eclectic and cursory way.? After that, it asks the harder question of how one can assure the preservation of wealth in a volatile world.? In a lesser way, I have talked about that recently.

Regarding the history of WWII, I came away with a greater appreciation of:

  • The troubles Britain faced.
  • The cruelty that the people in the nations overrun by Hitler and the Soviets faced.
  • The compromises many nations made to have an easier time in the War.
  • The courage that it took to oppose aggression in the face of initially bad odds.

One commonality between Germany and Japan was a lack of resources, and rather than produce and trade to get them, they chose conquest.

But the greater problem is how one preserves wealth over all contingencies.? The problem is almost insuperable.? Even as some wealthy people today are buying farmland, that was one strategy to preserve wealth in WWII.? Homely farms that were reasonably productive, but not ostentatious, were ideal to preserve wealth and lives.? Away from that, investing abroad was wise for the rich.? Also, commodities and TIPS, which did not exist then might preserve some wealth.? Gold and other precious items, if small could also preserve wealth, or at least life.

For those who live in the US today, we live in a special time and place.? We are free from the losses that come from aggression on our home soil.? We largely agree with one another, much as politicians may disagree on that point.? Americans are exceptional in so many ways, though not all of them are good.

Preserving wealth means owning productive land locally, and having flight capital abroad.? Away from that, Biggs counsels owning stocks because good times happen more often than they should.

I liked this book, more than many, and if you want to buy it, you can find it here: Wealth, War and Wisdom.

Full disclosure:? Publishers send me books.? I review some of them.? I try to review the best of them, but I promise the publishers nothing.? If you click on a link that leads you to Amazon through my website, and you buy something, I get a small commission.? My view is that you should buy what you want.? Don’t reward me for something that you don’t like.? Rather, enter Amazon through my website and buy what you want; it will cost you nothing more.

My TIPS, Treasuries, and Inflation Model — II

My TIPS, Treasuries, and Inflation Model — II

Posted on by David Merkel

I spent some time today updating my Treasury yield curve and inflation model.? Anytime a new Treasury note/bond is issued, or we get a new CPI figure, or a coupon payment date passes, the model must be updated.? Though I made some technical improvements to the program at the same time, what impressed me was the change in the forward inflation curve since I last wrote on the topic less than a month ago.

The big change is that inflation expectations rise? continually out to? 2038.? Now the TIPS curve only goes out to 2032, so the extrapolation should be discounted.? But the last time I wrote, inflation expectations peaked in 2022.? That is a significant change.? Investors have bid up the prices of long duration TIPS, to the point where I would be skittish about buying the long end of the TIPS curve.

Okay, let me post the graphs:

Using closing prices, here is my estimate of the coupon-paying yield curve:

And here is the spot curve (estimating where zero coupon bonds would price):

And finally, the forward curve, which estimates the expectations of future short-term rates, inflation, and real rates:

My model uses the whole Treasury and TIPS markets to estimate yields and inflation expectations.? Here is what is notable:

  • Inflation expectations on the long end have risen considerably over the last month.
  • I suspect that the US Treasury will be able to issue 30-year TIPS at yields lower than 20-year TIPS.? The new 30-year TIPS issue in February will prove me right or wrong.
  • Real forward yields are lower than zero 27 years out — that is unlikely.? I would expect nominal forward rates to rise on the long end.

There are at least two ways to view this situation:

1) Investor inflation expectations have overshot, and it is time to sell long TIPS and buy long nominal bonds, as long-term inflation expectations may fall in the future.

2) Time is running out — rapidly rising long-term inflation expectations indicate that the average investor does not trust monetary policy to succeed over the next 20+ years.

What would I do here?? I would hedge my bets, and buy some long Treasury zeroes (not a lot), mostly intermediate-to-long TIPS, and some short nominal Treasuries.? I would bias the portfolio in favor of bonds that are seemingly underpriced.

The hedged position is because I don’t know which direction the US Government and Fed intend to go with policy.? They likely have no idea as well; this is a tough situation.

On the deflationist side there is Hoisington, Gary Shilling, Carpe Diem.

More inflation-oriented are Greg Mankiw, Tim Duy, and Pimco.? But I don’t see anyone of significance screaming for high price inflation in the long-term future. Yes, that is the default view of much of the financial blogosphere, but the US Government had that option in the ’30s.? It would have made things a lot easier if they had done it, but they didn’t do it.? They acted in the interests of the wealthy, rather than the interests of the economy as a whole.

That’s what makes my model interesting.? It shows that there is a lot of demand for long TIPS.? If the US Treasury thinks it can get things under control, the rational thing to do is to stuff the long TIPS buyers with as much product as they can gulp before it becomes obvious that low inflation will continue because the government will soon balance the budget and pay down debt, as they did after WWII.

But if the US Treasury can’t get things under control, the long TIPS buyers will do well, as they have the most sensitivity to rising forward inflation expectations.

Where do we go from here?? My guess is slowly rising inflation with a weak economy.? But so much depends on the rest of the world, that I hold that opinion skeptically.

Full disclosure: I own some of the Vanguard TIPS fund [VIPSX].

Rationality versus Time Horizons

Rationality versus Time Horizons

Posted on by David Merkel

Would that there were one time horizon — a goal to shoot for, similar to the dispensationalists that plague Christianity with an announced date for the return of Christ.? But a major reason that the Chicago School (as well as the Keynesians) is wrong in their view of economics is that there are multiple time horizons that people consider.

Why one time horizon?? It makes the math simple.? It is similar to the foolish Modern Portfolio Theory which has one version of risk which bears no resemblance to risk in the real world.? Modern Portfolio Theory exists so that bright people who can’t interpret the real world can receive salaries and look smart.? What’s that, you say, Modern Portfolio Theory has a fixed time horizon?? Another reason to cast it over the edge.? It is useless.

There have been a series of interviews at The New Yorker with Chicago School economists to try to test them in their allegiance to the free markets.? There is a problem here in that what makes sense in the short run does not always make sense in the long run.

Bubbles develop from short-run thinking.? What has worked in the immediate past? will work even better in the future.? In hindsight, it sounds dumb, but remember that most people are imitative; they imitate the seeming success of others.? People are rational, but not rational in the way that most economists posit.? Imitating your neighbor is a logical move for many actions.? If he is doing something that looks good, it can make a lot of sense to do the same thing — e.g., asking for the recipe for the delicious meal you had at their house, as well as asking where they got a certain obscure ingredient.

Imitation conserves on thinking.? People avoid thinking, because it hurts.? “If it works for my loser brother-in-law, than it certainly will work better for? me,” is the way some think.? There is the implicit appeal to taking an action out of greed or jealousy.? Smart people avoid those temptations, and think for themselves, looking to the long term consequences of any action.

Momentum investors live on the short-term horizon; value investors invest for the long term — if success comes quickly, very good, if slowly, good.? The ability to wait is a plus, because the ability to wait allows for optionality that may produce more value.

Back to bubbles.? They usually exist because financing is too cheap relative to what financing costs on average over a full market cycle.? Lending or equity investing at such times goes on with little thought for what can go wrong.

“This junk bond won’t default.”

“This equity will grow into its valuation, and then some.”

But near the peaks of bubbles, two things happen.? The prices of the assets being financed are so high, that one borrowing to own the asset faces a negative arb — he has to keep paying to keep the asset afloat — the net yield is negative.? The second thing is that chatter becomes uncertain, and the pace of closing deals slows.

These are signs that the cash flows that the assets throw off are less than the cash flows needed to hold the assets.? Such a condition can only exist for a short time during a mania.? When the pace of deals slackens, and the arb is negative it is time to run, not walk to the exits.

If enough economic actors did this, bubbles would self-deflate.? But it hurts to think.? Valuation questions are tough, and it is much easier to mimic the seemingly successful actions of others.

Better it would be if the Fed, which is the main blower of bubbles through easy monetary policy, would pull back on policy when aggregate levels of debt in the economy get above 200% of GDP, or, would allow us to go through recessions where there is significant pain, and liquidation of bad investments.? But no, during the bubble years, Greenspan was lionized for keeping the economy going smoothly — limiting the impact of recessions.? All that time, debts kept building up until the ratio far exceeded that achieved during the Great Depression.? Now Bernanke is lionized for increasing the Debt/GDP ratio while shifting debts from private to public hands.? He has saved us from the final reckoning of debt service.? Now what will the US Government do as its total obligations pass 4x GDP and head toward 5x GDP?? As I have said before, we are in uncharted waters here.

Debt is not neutral.? It creates inflexibility in the economy, because an economy built on fixed commitments has higher bankruptcy risks than one built on equity commitments.? Real reform would force banks to delever.? It would force the US Government to delever.? Real reform would get the government out of the prosperity business (it has never been good at that), and get it to focus on areas where it can make a difference — justice, defense, public health, and other public goods.

One simple solution: phase out the deduction for interest expenses, and phase in a deduction for dividends (preferred dividends would be at 50%).? Disallow trust preferred and hybrid debt structures.? Make finance more transparent by eliminating complex structures, and limiting all derivative transactions such that only hedgers may initiate transactions.? Transactions between two speculators should be regulated as gambling, because that is what it is.

If the government is not willing to take actions that hurt those being regulated, they are not worthy of being called a government.? The government should look out for the best interests of the nation as a whole, regardless of whom it might seem to favor.

Once again, back to bubbles.? Bubbles don’t get popped by the powers that be because the powers that be like bubbles as they are inflating.? Who would be a humbug and stop the sunbeam of prosperity when it is shining with full power?

But when the deflation of the bubble happens, everyone points the finger outward, few point at themselves.? Let Messrs. Greenspan, Paulson, Geithner, and Bernanke, among others, come before the cameras and apologize for their mismanagement of the US economy, and, let them suggest that the government get out of the economy business, because the government has consistently failed there.

To come back to the beginning of this article, the fetish of rationality exists in economics because the math doesn’t work without it.? Many tests of rationality have failed, yet the profession does not give up, because their skills are useless if man is not economically rational.

It is time to unemploy a lot of economists.? Unemploy them at the Fed; if we don’t eliminate the Fed, at least let’s slim it down.? Unemploy them at universities and colleges.? Let the business departments teach practical economics, and close the economics departments themselves.

The failure of Keynesian, Chicago School, and Neoclassical economics in this present crisis is severe.? We need a new economic paradigm to replace the failures that exist within our universities.

Neoclassical economics will fail; I may not live to see it fail, but it will fail.

Book Review: The Only Three Questions That Count

Book Review: The Only Three Questions That Count

Posted on by David Merkel

I resisted getting this book when it first came out.? Much as I enjoy Ken Fisher as a writer, and appreciate the interaction that I have had with him over the years, the title turned me away.? “Three questions? Only three?? Investing is far more complex than that.”? I would say that to myself.

After reviewing his most recent book, I said to myself, “Well, you’ve reviewed all of his books but one; you may as well do it.”? So, I borrowed the book from a friend.

I wish I had read it sooner.? The three questions are simple ones, and they have been mentioned elsewhere on the internet, so here they are:

  • What do you believe that is actually false?
  • What can you fathom that others find unfathomable?
  • What the heck is my brain doing to blindside me now?

The idea is to get us to think more deeply.? Test the received wisdom to see if it is really true.? Look for unusual areas of competitive advantage that you have that are possessed by few.? Your emotions will often lead you astray: look for opportunity amid fear; look for shelter amid wild abandon.

Competitive advantage in investing is an elusive thing.? The clever idea that you might discover is just one journal article away from an academic toiling in obscurity, but will go to a? hedge fund two years from now.

Patterns that work in one market should work in most markets.? If your discovery seems to work in most places, it might work well, until it is discovered and used heavily.

I found a number of insights useful.? Like me, he uses E/P relative to bond yields to try to estimate whether markets are rich or cheap.? I also found his insights about how the yield curve affects style investing to be useful.? I do something like that through my industry rotation.

Now, in the intermediate-run, most things that people are scared about don’t affect the market much.? Government deficits seem to be a positive for stocks in the short run.? Trade deficit?? Little effect on stocks.? Weak dollar?? Little effect.? This book debunks a number of common worries, though I would say that if the problem got significantly bigger, perhaps the result would be different.

Ken Fisher offers what I would deem to be good advice on Asset Allocation, and how to make sell decisions, amid many other issues.? I enjoyed the book a lot, and would recommend it to my readers.

Quibbles

Occasionally, the book seems disjointed.? Ken Fisher is covering a lot of ground, and he takes a decent number of “side trips” to explain concepts.? The flip side of that is that the book covers many areas of the equity markets, and helps to explain what drives them.

Now, sometimes I wonder if multivariate approaches might reveal different conclusions than what Ken Fisher comes to.

Who would benefit from the book: Investors with moderate experience in investing who are finding the going harder than they expected.? This book will help them take a step back, and think twice about investment decisions.

If you want to buy the book, you can buy it here: The Only Three Questions That Count: Investing by Knowing What Others Don’t (Fisher Investments Press)

Full Disclosure: Book reviews are my main profit center at my blog.? They allow me? to create a win-win situation for me and my readers.? I don’t want my readers to waste their money to reward me.? I would rather they buy things that they want to buy at competitive prices through Amazon.? If they enter Amazon through my site, I get a small commission, and their price does not change at all.? Such a deal.

R Bonds R Bad 4 U

R Bonds R Bad 4 U

Posted on by David Merkel

I have long been a fan of immediate annuities, particularly those that are inflation indexed, as retirement products for seniors.? Yet, they do not get bought by retirees.? Why?? Well, insurance products are sold, not bought, typically, and when the agent sells an immediate annuity, that is his last sale on that money.? They would rather sell a less suitable product that offers them another sale down the road.? And, people like having flexibility with and control over their investments, even if that leads to less money for them in the long run.? Annuitizing a portion of one’s lump sum lowers risk, and takes the place of investing in bonds in the asset allocation.

Most people like the reliability of their pensions, and Social Security, should it be paid, but do not seek the same thing when investing their private money.? One would think they would invest that money for growth if they had a strong stream of income elsewhere, but often that money is conservatively invested as well.

People get fooled by yield, and in an environment like this, more so.? People try to make their investments do more through targeting higher yields, while ignoring the possibility of capital losses.

Most people can budget, if pressed to do so.? Few can manage a lump sum of capital, and know what to invest it in, and how much to take from it per year.? Few have the discipline to buy an immediate annuity or limit their withdrawals to 4% of assets per year.

But where there is chaos and confusion, some in our government will seek to create a “solution.”? The ill-defined solution that sounds a bit like a Stable Value Fund is what is getting called “R Bonds.”? Here’s the idea: for those with 401(k)? or IRA balances, if they should retire, and not decide what to do with the money, the assets would get automatically get placed into a Retirement Bond, and for two years, the retiree would receive income.? They can opt out before that happens.? If after two years they still don’t decide, the income continues.? There is nothing mandatory about this program, should it come into existence; people who are asleep about their finances may find themselves trapped in it, at least for a time. [Note: there are scandalmongers alleging out-and-out theft being planned by the US Government.? From what I can see that is not true for anyone that keeps his wits about him.? All the proposals allow people to “opt out.”]

But let me go further.? Scrap the idea of “R bonds.”? Issue a limited number of Trills for retirees to use, or create a special variant of TIPS that pays until someone dies.? These are easy solutions that do not require a lot of changes to the legal codes, or changes in investment behavior.

Now, there is not just one proposal out there.? Let me give the two most comprehensive:

With interest rates so low on the short end, I don’t see how the returns could be that great from “R Bonds.”?? I would play for higher returns given the risk of inflation.? Today that would mean safe stuff that yields little, while waiting for a correction in the fixed income markets, and high quality common stocks with some yield.? And, annuitization at present?? I would wait for higher rates.

Other posts on the topic worthy of your consideration:

Now, all that said, there is a reason to be politically aware here.? Governments have in the past forced people to convert assets that were more valuable for those that were less valuable.? And, we have the example of Argentina doing it in the present with pension assets, and also when their currency blew up — most debtors faced a forced conversion to less valuable bonds.? With the pension nationalization, it was done in the name of protecting people’s pensions, but ended up benefiting the finances of the Argentine Government.

So, be aware.? R Bonds, as currently proposed, are a bad idea.? But there are worse ideas not yet proposed that might be proposed in the guise of protecting your future.? Let us work to make sure they never get implemented.

Fat Fed Profits Do Not Create a Healthy Economy

Fat Fed Profits Do Not Create a Healthy Economy

Posted on by David Merkel

1) Inflate the size of my balance sheet by 2.5x over last year, all through borrowing at really low rates.

2) Increase my interest spreads by ~50% over last year.

means:

3) I only increased my profits by ~50% over last year??!? :(? I would have thought that profits would have more than tripled.

Such is life for the Fed.? The crisis was a time that led me to write pieces like The Liquidity Monopoly, where the Fed, FDIC, and Treasury played favorites in the economy, and starved the portions of the economy not dominated by large firms, particularly with banks and autos.

My main point is that the Fed should have earned a lot more.? Where did it all go?? It will be interesting to see a detailed rendering of the Fed’s finances when this is done.? Did they realize losses on some of the assets that they bought?

My friend Peter Eavis of the Wall Street Journal agrees.? Or, read Felix, and then read the exchange between my two friends Alea and Kid Dynamite.? Alea knows more, but I like KD’s spirit.

The Fed has become more like the banks that it regulates.? They are taking on credit risk, duration risk, convexity risk, etc.? And being a government institution, they don’t have good incentives for knowing how to price risk.

So, when I see the Fed’s seniorage profits up only 50%, I am not impressed.? The Fed doesn’t mark to market, so we really don’t know the true performance.? Also, remember that seniorage profits are a hidden tax on savers, would earn a higher yield if the government provided less financing.

Part of why we end up in an economic funk is that we finance dud assets at favorable rates, so capital does not get redeployed to better uses.? Aside from that, cheap leverage creates a yield frenzy over healthy assets, so that they can become over-levered as well.? Examples are numerous:

To me it is no great achievement that the financial markets are doing well while the real economy is in the tank (Unemployment, Production).? That is the nature of what happens when credit is force-fed into an economy, even leaving aside the problems of cronyism.? There should be no optimism over the large profits realized by the Fed; it may defray our taxes, but on net, the policies have not helped create a healthier real economy.

Don’t Strategically Default on your Mortgage

Don’t Strategically Default on your Mortgage

Posted on by David Merkel

I like Roger Lowenstein; he is a bright guy.? I have reviewed several of his books, and would recommend to readers that they are worth buying.

But, I disagree with Lowenstein in some ways regarding defaulting on home mortgages.? I want to give some credit to my wife here.? My dear wife of 23 years, who I thought about many times while we were attending a wedding today (I could not sit with her because I was leading the singing), and who does not have an economic bone in her body, helped me think about the issues around defaulting on home mortgages.

There is a false notion that because firms default when it is in their economic interest to do so, so should homeowners whose mortgages are greater than the underlying house value.

First, firms can’t so easily enter Chapter 11.? How does Chapter 11 work for firms?? Two things must be true — a firm must not be able to raise cash to make a debt payment, and the assets of the firm are worth less than the liabilities.? If a firm can’t pass both tests, the bankruptcy court should refuse the filing, forcing the firm to sell assets to make a payment.

To use this analogy for defaulting on a home mortgage, it is one thing to take out a mortgage in buying a home, having reasonable margins for error, and then disaster hits, and the mortgage payment can’t be made.? It is quite another thing to have the capacity to make the mortgage payment, and default.? Corporations usually can’t get away with that (please ignore KMart); if they can make payments on the debt, they can’t go into Chapter 11 bankruptcy.

Bankruptcy primarily exists as a protection for borrowers who have suffered loss, leading to inability to pay their debts.? It does not exist to allow people with the capacity to pay to slip out of contracts, simply because the creditor won’t go after them because it is not worth their effort, or, they don’t want the negative PR.

Would you borrow from a relative and default, because you know they would never sue you?? Would that be ethical?? Taking advantage of the extreme kindness of others may be legal, but it is never ethical.

If you can pay, you should pay.? That the mortgage lender will not enforce their rights does not mean that the one who can pay but defaults is ethical.

Imagine a society where any can default at their pleasure.? My, but the interest rates should get high to reflect the possibility of loss from borrowers that could pay but won’t.

If you can keep your word, and make your payments, do so.? You entered into the mortgage agreement with no assurance of where housing prices would go.? That they turned against you is no reason to default; but if your ability to pay has declined, well, that is another thing — default if you must.

Book Review: Why are we so Clueless about the Stock Market?

Book Review: Why are we so Clueless about the Stock Market?

Posted on by David Merkel

This is a basic book.? If you are trying to introduce someone to investing, this would have value.? It uses concepts familiar to every man to explain that there is nothing amazing about good investing — it is just common sense sharply applied.? In terms of deep insight, I don’t see a lot of it, but that is not what the book is aimed at.? The book is for new investors looking to understand the markets.

There is much that is good here, but nothing deep.? If you want to buy the book, you can buy it here: Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market.

Full disclosure: Anyone who enters Amazon through my site and buys something sends me a commision.

The Trill is Gone

The Trill is Gone

Posted on by David Merkel

This should be my last post on Trills.? Let me begin it by suggesting that we sell all of our national parks (and other land owned by the US Government) to the Saudis in exchange for forgiveness of our debts.? Wait, we could do better.? Disney could create theme parks, even on the national mall, making being American far more fun than the stuffy Smithsonian.

What’s that you say?? We are selling our patrimony?? How dare we sell our precious resources to exploiters/foreigners?? Uh, times are tough, and much as we make paper promises, eventually something hard and enduring has to back them up.

I feel the same way about Trills.? If the US Government ever were to sell trills, it would be the same as selling away a share in the take from the IRS in perpetuity.? Selling shares in the IRS, ridiculous, right?? Well, that is what a trill is — selling a share of the IRS.

Imagine that the US Government taxes at 20% of GDP, and then they sell Trills equal to 1% of GDP.? Initially, the US? Government would get a flood of cash, but would have given up 5% of their income stream.? If we had angels running our government, focusing on long-term projects, I would not object so much, but we spend in the present and neglect the future.

A government that issues Trills reduces its flexibility.? Initially not so, they get a lot of cash in, and don’t have to put a lot out.? The US government at present has explicitly issued debt with a market value around 75% of GDP.?? Implicitly, the funding shortfall when you add in the excess liabilities from the entitlements is 400% of GDP.

To keep things simple, let’s assume that the initial yield of Shiller’s trill is correct (1%), not only for small amounts of issuance, but large amounts.? That is probably a bad assumption in this case, after all, the proportion of Treasury issues out past 20 years is a small minority of Treasury issuance, and even with existing demand, the yield curve is quite steep.? Trills, being perpetual bonds with a growing coupon, are longer than any fixed income instrument that I have ever seen, so if they were issued in large amounts, who knows what the initial yields would be?

(Note to potential investors: if trills ever see the light of day, they could be an interesting buy, but I would let the first few auctions pass until the curve gets satiated and the initial coupon rises to a higher level, i.e., the price falls for all trills. You might even wait for the government to announce the last trills auction to buy.? One thing about trills — every issuance will raise additional doubts about ever being paid back.? They would be more valuable when the government says it won’t create any more of them.)

So, back to the application, imagine the US government auctioning off $11 Trillion (yes, with a “Tr”, not a “B”) of trills to retire the explicit debt.? Assume that the 1% initial coupon holds — we have now walled off 0.75% of GDP as a permanent expense in the Federal budget — keeping the numbers simple, that would be 3.75% of all Federal revenues in perpetuity.? Doesn’t sound like much, but we replace the existing debt with a exponentially growing stream where debt service is initially $110 billion.? That could help balance the budget at present, but at a cost to all future generations, until the US shall be no more.

Now, the 1% initial coupon would not hold for such large issuance.? Say the coupon ends up being 2%.? Now 7.5% of Federal revenues are dedicated to debt service in perpetuity, and 1.5% of GDP.

This would become addictive to the US Government — trills raise a lot of money relative to their initial cashflows, and they have no rollover risk.? Now imagine the US issuing a present value of $70 Trillion in trills (5x current GDP) over the next 30 years to roll over existing debt, take care of all the unfunded liabilities, and cover all of the structural deficit for the next 10 years.? At my assumed coupon of 2%, that would wall off 10% of GDP in perpetuity, or half of Federal revenues to pay for the sins of the past.? The bad human proverb recorded in the Bible might return to common parlance, “The fathers have eaten sour grapes, and the children’s teeth are set on edge.”? (Note: at/near the exile of Judah, some complained they were being punished for the sins their forbears committed, and not their own sins.? God corrects the proverb, saying that people are punished for their own sins.)

Potentially, trills are a heavy burden to place on all future generations for the fiscal profligacy of the last 80 years.? I would rather not see trills see the light of day as a result.? It would postpone the eventual day of reckoning where the US Government would have to slim down dramatically, and live within its budget.? Trills would make the US government more reckless, not more cost conscious.

But, if trills are to be issued, let some more desperate entity issue them first, like Greece or California, and then let the rest of us watch the consequences.? They would provide help in the short run, at a likely cost of a bigger failure later, with more damage to creditors, and the general economy.

This should be my last piece on this, though one final thought tugs at me — the derivatives market that would grow up around trills would be a hoot.? GDP futures and options, stripping coupons to create discount trills and income trusts.? The investment bankers would have a field day, with the cheap cost of burdening all future generations, who I am sure will remember Dr. Shiller warmly.

Fourteen Comments on the Financial Economy

Fourteen Comments on the Financial Economy

Posted on by David Merkel

1) Yield-seeking — it is alive and well.? Check out this article on pay-in-kind bonds.? With PIKs, one can be concerned with the return on the money, and the return of the money at the same time.? The history of returns on PIK bonds are such that you are usually better off putting the money under a mattress.

2) More yield-seeking — spreads on mortgage bonds over Treasuries are at a 17-year low, and as I measure it, and all-time low.? Investors have gone maniac for GSE insured mortgage bonds.

3) I am as close to neutral on PIMCO as anyone I know.? I have written articles explaining how they make money, which is different from the public pronouncements of Gross and McCulley.? The current missive of Gross impresses me as fair, recognizing the limits of the Federal Government and the Fed.? PIMCO is taking less risk, selling US and UK debt, and buying German debt.? This is conservative; they are giving up yield.

4) Bruce Krasting notes that the Social Security system paid out more in 2009 than it took in.? That event was not supposed to happen until 2016 or so.? Aside from that, he notes the negative COLA adjustment.? As for me, I look at this and say, “Whether it comes slower or faster, it will come.? Medicare and Social Security will destroy the Federal budget eventually, or will be scaled back to where those that were taxed complain about it.

5) If you want to consider a technical reason for rates being so low, consider all of the mutual fund buyers.? They have favored bonds.? This is a contrary sign for interest rates — they are headed higher.

6) Bernanke blames bank regulation so that he can absolve monetary policy.? Typical.? Blame what you control less, to absolve what you control directly.? A better and brighter economist (in my opinion), John Taylor disagrees.? He views the mid-decade low rate policies as contributing to the lending frenzy.? Don’t get me wrong.? Bank regulation was lousy, but monetary policy was lousier, helping to create the boom that now gives us the bust that normalizes things.

7) How amazing was the junk bond market?? Better, how amazing was the distressed debt market?? Oh my, though junk bonds paced equities, distressed debt did far better.? Such is the case when a turn happens; this one was forced by the US Government.

8) If you want to understand how finance reform gets blocked, read this article.? Better than most, it explains the intricacies of why the Democrats have a hard time passing the legislation that the radicals would like.

9) I am not a Buffett-lover or hater.? When I read his opposition to Kraft raising its bid, I said to myself, “Of course.? Don’t overpay.? Most deals are best avoided.”? Which is true — M&A is in general a value destroyer.

10) Personal bankruptcies are rising in the US.? It is a messy time.

11) Let the Chicago School of Economics die.? I have already argued for their demise.

12) The CMBS market is experiencing delinquencies that have not been seen before.? This is just another example of the difficulties many commercial mortgage loans are in.

13) Strip malls have high vacancy rates.

14) I appreciate Tyler Cowen’s article, suggesting that things are pretty good.? We should be glad that other places in the world did well, even if we did not do so well.

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