Category: Real Estate and Mortgages

Redacted Version of the September 2013 FOMC Statement

Redacted Version of the September 2013 FOMC Statement

Posted on by David Merkel
July 2013 September 2013 Comments
Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Shades their view of GDP growth up.
Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. Adds weasel words because the participation rate is falling, and wages are stagnant.
Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth. Shades their view of housing down.? The Fed hasn?t learned that they can?t control the long end of the yield curve
Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Little change.? TIPS are showing similar inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.45%, down 0.05% from July.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. No change.Emphasizes that the FOMC will keep doing the same thing and expect a different result than before. Monetary policy is omnipotent on the asset side, right?
The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. Does not take credit that the tightening of financial conditions happened largely because of FOMC communications.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term. No change.? CPI is at 1.8% now, yoy.? It may be closer than they think.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. The notable paragraph, saying that the ?taper? is not starting because fiscal policy is not as stimulative as the Fed wants.
the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. 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. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. 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 real change.Operation Twist continues.? Additional absorption of long Treasuries commences.? Fed will make the empty ?monetary base? move from $3 to 4 Trillion by the end of 2013.

 
Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will closely monitor incoming information on economic and financial developments in coming months No change. Useless comment.
The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No real change.
The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Drops the concept that they might increase the pace of purchases.? Aside from that, this section says about the same thing as July.
Asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases. New sentence, but it really doesn?t add much.? Didn?t we know that already?
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. No change.Promises that they won?t change until the economy strengthens.? Good luck with that.
In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. Not a time limit but economic limits from inflation and employment.Just ran the calculation ? TIPS implied forward inflation one year forward for one year ? i.e., a rough forecast for 2014, is currently 2.39%, up 19 bp from July.? Here?s the graph.? The FOMC has only 0.11% of margin in their calculation.

 
In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Two doves leave the FOMC
Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. George continues to make her point that is the same as mine in my piece Easy In, Hard Out; that the Fed may have greater problems as a result of its abnormal policies, whatever they do in the future.

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Comments

  • No taper yet.? Equities, long bonds, and gold rally.? The FOMC says that any change to policy is contingent on almost everything.
  • They shaded their views of housing down and GDP up.
  • Longer statement.? They think that if they use more words, they will be clearer.? Longer statements are harder to parse and understand.
  • Current proposed policy is an exercise in wishful thinking.? Monetary policy does not work in reducing unemployment, and I think we should end the charade.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis. ?Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Companies & Industries

 

  • Falling gas prices this Fall http://t.co/EQkgsyKoSm Pollution requirements fall, people drive less, overcomes geopolitical effects $$ Aug 30, 2013
  • Wal-Mart vs Costco, Why My Critics R Wrong http://t.co/2eBuKkJ8G2 $WMT offers more variety vs $COST | thus more people lower wage rates $$ Aug 30, 2013
  • Brazilian Billionaire Who Controls Your Beer, Condiments, & Whopper http://t.co/CbfdxNQLAP Long piece on Jorge Lemann $$ #Heinz $BRK.B Aug 30, 2013
  • New York to Seattle Buyers Tap Brakes After Rates Rise http://t.co/uU0NS9CiCU Rising prices & mortgage rates mean loan payments 2 high $$ Aug 30, 2013
  • US Bank Legal Bills Exceed $100B Bloomberg http://t.co/BklYyebbFV Just think how profitable they will be when the dust settles 😉 $$ Aug 29, 2013
  • Cheap Corn Deters Buyers in US Sugar-for-Ethanol Plan http://t.co/sAYPAt1G9g Corn scarcity becomes corn glut, reinforcing sugar glut $$ Aug 29, 2013
  • Why Wal-Mart Will Never Pay Like Costco http://t.co/EPVjeV0OvF $WMT has much wider diversity of products, so more workers @ lower pay $$ Aug 29, 2013
  • Why Is Chicken More Expensive? Ask McDonald’s http://t.co/iU7OzuIF8f When $MCD adds a new ingredient to their menu, drives prices higher $$ Aug 29, 2013
  • Xerox Can Fix Number-Switching Scanners, but Not Altered Docs http://t.co/6HfzO8IqtV Could b a lot of work 2 re-scan originals if u havem $$ Aug 27, 2013
  • JPMorgan Worth 30% More If Broken Up, KBW Says http://t.co/b5eJc14Lio Pure play financial institutions always get better valuations $JPM $$ Aug 24, 2013
  • Apple, Samsung, IBM, World’s Universities in Graphene Gold Rush http://t.co/riFRiMHAzN Crystalline Carbon 1 atom thick sheets are amazing $$ Aug 24, 2013
  • College is like gasoline, demand for it is inelastic. Thus any subsidy gets captured by the college, & taxes get eaten by gas consumers $$ Aug 24, 2013
  • The Real Reason College Costs So Much http://t.co/NJNV3Ksovg Richard Vedder explains how federal subsidies push up the price on college $$ Aug 24, 2013
  • djco_corresp-031513.htm http://t.co/VwvVLv7mZi Munger’s law firm explains y $DJCO shouldn’t b viewed as an investment company. Well done! $$ Aug 24, 2013

US Politics & Policy

 

  • Obama Is About 2Undermine His Mideast Doctrine http://t.co/VveJslt6LM Obama has mostly tried 2disengage US from Mideast, this reverses it $$ Aug 30, 2013
  • The Rising Cost of Social Security Disability Insurance http://t.co/4sEVmFKDfc SSDI’s trust fund runs out is 2016; 2EZ 2get on disability $$ Aug 29, 2013
  • And Next Year There Will Be an Eighth Budget ?Showdown? http://t.co/2nflqEZLPM Rate of budget growth slowed, but scope of govt expands $$ Aug 29, 2013
  • Regulators Ease Mortgage Rules http://t.co/LuEU9uY1Hz Swiss cheese regs destroy direct incentives 4 originators 2 produce quality loans $$ Aug 29, 2013
  • Regulators Back Away From Tougher Mortgage Rules http://t.co/4WQwGVNnF9 More capital needs to be held against exotic mortgage loans, good $$ Aug 29, 2013
  • Obama Meets Panel Reviewing US Surveillance Programs http://t.co/kjDsoD3K7D Repeal the Patriot Act; modifications r not enough $$ Aug 28, 2013
  • College Leaders Wary of Obama Plan Linking College Aid to Rank http://t.co/jw7K3X29TV Plan could hurt the very parties Obama wants 2 help $$ Aug 25, 2013
  • Samantha Power on the Duty to Intervene http://t.co/B4ttOrPB3T This argues that the US should be the cop of the globe 4 the worst things $$ Aug 25, 2013

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Rest of the World

 

  • Sinopec-Apache Deal Shows China’s Resource Appetite http://t.co/90Yr1G9aUN China learns how 2negotiate minority stakes in oil properties $$ Aug 30, 2013
  • Hollande Draws Heat From Biz 4 Tax-Driven Pension Revamp http://t.co/62E5lKMHqr France?s tax burden is ~46% of GDP, 3rd highest in Europe $$ Aug 30, 2013
  • Scandinavia?s Weakest Nation Finds Welfare Habits Too Costly http://t.co/UCNH3umT7p Denmark looks forward, realizes it must cut welfare $$ Aug 30, 2013
  • The Abenomics Mirage: In Reality, Too Many Challenges? http://t.co/542B5V4JHw Japan imports on net so a lower yen doesn’t help much $$ Aug 30, 2013
  • Schaeuble Snubs Greek Plea for Direct Bank Recapitalization http://t.co/lCStBdF3Qc Perhaps Greece needs 2 establish effective taxation $$ Aug 29, 2013
  • Spaniards Fleeing Jobless Scourge Seek Jobs in Morocco http://t.co/pZZexcIzCY Can’t earn as much but can earn something as Spain shrinks $$ Aug 29, 2013
  • Start-Ups Fill Void Left by Spain?s 26% Unemployment Rate http://t.co/9a2RqRUG6i If u can’t work 4 someone else u can work 4 yourself $$ Aug 28, 2013
  • Czech Zero Percent Lending Rate Feeds Home-Buying Frenzy http://t.co/cWZ24eKjxb Bad things happen when there is seemingly free $$ available Aug 28, 2013
  • Vietnam Rises as Middle Power at Defense Summit http://t.co/tHVz8Yn4SP Wants to stay neutral btw the US & China, while protecting itself $$ Aug 28, 2013
  • Teachers Roil Mexico Capital http://t.co/qrQif3mpsY Maybe it’s time 2 move the capital out of Mexico City, to someplace more hospitable $$ Aug 28, 2013
  • Emerging-Market Rout Intensifies on Syria Jitters http://t.co/U4upWVYVAE Jitters affect oil mkt & it spills over in to weak emerging mkts $$ Aug 28, 2013
  • Fed Officials Rebuff Coordination Calls as QE Taper Looms http://t.co/kTaFgn7CwT Emerging markets whipsawed as US monetary policy shifts $$ Aug 28, 2013
  • Veteran Saudi Power Player Prince Bandar Works To Build Support to Topple Assad http://t.co/cXFO7hLG9W Islamic proxy war continues $$ Aug 27, 2013
  • Emerging Europe Is a Haven in Selloff http://t.co/OErr8eqJjt Hard to damage nations w/more orthodox fiscal policies, but still part of EZ $$ Aug 27, 2013
  • Emerging market slump highlights Fed’s global reach http://t.co/mxmfLY6ya2 The US sneezes & the world catches cold, again $$ Aug 27, 2013
  • Charlene Chu Interview with Goldman on China?s Credit Bubble http://t.co/ytHhrZYm7H Excellent Interview showing future China weakness $$ Aug 27, 2013

 

Other

 

  • Scientists Shed New Light on Black Holes http://t.co/oNyfGEJKHM The speed w/which gas is pulled toward a black hole repels some entering $$ Aug 30, 2013
  • Is It Evil to Send Your Kids to Private School??http://t.co/SljCeNm7qq Parents will always find ways 2keep children out of subpar schools $$ Aug 30, 2013
  • Age-Related Forgetfulness Tied to Diminished Brain Protein http://t.co/fFe2U2eqQw This may have some promise in reducing dementia $$ Aug 30, 2013
  • Definitive merger agreement between 2 business journalists http://t.co/Pup53ksizg Do some R&D, & create subsidiaries that will b spun off $$ Aug 30, 2013
  • How Haute Vegetables R Conquering $500 Tasting Menus http://t.co/QTAxKlwm1S Borage is a well-known medicinal herb; interesting 1st course $$ Aug 29, 2013
  • Six Reasons the US Will Dominate http://t.co/ZreqluzZJS Immigrants, more workers, entrepreneurship, labor flexibility, <Financing, strong $$ Aug 28, 2013
  • P2P lending pulls in big investors – should you bite? http://t.co/jyg3kdaSrr Soon 2 come, a peer2peer lending closed-end fund $$ #ohno #FTL Aug 28, 2013
  • Shoeshines Keep Wall Street in the Black (or Maybe Brown) http://t.co/LQNtODrhcP A unique institution stays alive on Wall Street $$ Aug 27, 2013
  • Sometimes I think Federal education policy is designed to weigh down the system, making it easier 4 private & home schools 2 outperform $$ Aug 27, 2013
  • Biggest Changes in a Decade Greet Students http://t.co/BIgJHbqiLN Some Teachers, Parents Push Back on New Standards “Common Core” $$ Aug 27, 2013
  • Home Births on the Rise for New York Families http://t.co/MYxaaeEWua Fascinating trend, though I think the best is a midwife @ a hospital $$ Aug 27, 2013
  • Midwives provides far better care than doctors w/normal deliveries, & they r cheaper. Being @ a hospital provides insurance if trouble $$ Aug 27, 2013
  • Are You Ready for the Post-College SAT? http://t.co/WyscN8A7W6 College is not valuable to some employers -> a new test 2 show your smarts $$ Aug 27, 2013
  • Regarding that last tweet, could testing replace college? Credentialing is important, but do we need to waste four years to credential? $$ Aug 27, 2013
  • Jail Becomes Home for Husband Stuck With Lifetime Alimony http://t.co/Mb4Q8Q0PjH Debtors prison returns in a new form $$ long article Aug 27, 2013
  • Muriel Siebert, First Woman to Buy Seat on NYSE, Dies at 84 http://t.co/qzeE9csU2K Used to have an account w/her firm; good company $$ Aug 27, 2013
  • Ben Franklin Gets a Makeover http://t.co/Rxm3ipFY0g Ben Franklin owned slaves?! Whouda thunk it! New presentation about a complex guy $$ Aug 25, 2013
  • Dishwashers Beat Clothes as US Moms Use Hand-Me-Downs http://t.co/cbcn0ENrp1 People buy things w/longer-term value, reduce luxuries $$ Aug 25, 2013

 

PPACA / Obamacare

 

  • A New Kind of Insurance Head-Scratcher: Estimating Future Income http://t.co/YeW19BKNhf Incentive will b2 under-report until checked $$ Aug 30, 2013
  • The Young and the Healthy http://t.co/PuODKsJBSZ One more calculator 4 Obamacare subsidies 4 young & not well-paid $$ Old win, young lose Aug 30, 2013
  • Senior Discounts http://t.co/Do37iNPq7I Interesting illustrative calculator on premium subsidies under Obamacare. Incentives to earn less $$ Aug 30, 2013
  • Thus PPACA will have an incentive 2 destroy working, & the exchanges will fail, as they will only attract the sick, young ppl stay away $$ Aug 30, 2013
  • Also, look at this graphic http://t.co/WTV8HAcVVZ As incomes go from 25K to 55K, subsidy is lost & an implied 17% tax from the loss $$ Aug 30, 2013
  • Subsidies for Older Buyers Give Health Insurers a Headache http://t.co/0eOfVj33XU Subsidies will will older poor in2 exchanges, not young $$ Aug 30, 2013

 

Harbinger Group Life Insurance IPO
?? Falcone Insurer Said to Seek $1 Billion Valuation in IPO – Bloomberg http://t.co/RoHy0ODzQu & my tart comments: http://t.co/JSu9QvtXhf $$ Aug 30, 2013

  • Harbinger’s insurance unit files for $100M IPO http://t.co/72DBoMSG6C $HRG pays itself a dividend; dig the 28pp of risk factors @ the SEC $$ Aug 29, 2013

 

Market Impact

 

  • Pimco Sees Taper in Worst MBS Slump Since 1999 http://t.co/UdXVCkajVo Bond market summary, particularly noting taper effect on MBS market $$ Aug 30, 2013
  • Some IPOs Aim for Small Investors http://t.co/3hh47lfQ6K Keep your hand on your wallet, alternative stock distribution methods untested $$ Aug 30, 2013
  • Currency Spikes at 4 PM in London Provide Rigging Clues http://t.co/fyG78r3RhI All human systems r gamed; need 2 acct 4 that w/benchmarks $$ Aug 28, 2013
  • How ?black squirrels? infested Wall Street http://t.co/6CIVfJcpAF Efforts to level playing field made it more opaque & hazardous $$ #complex Aug 27, 2013
  • Cyclical Stocks Looking Historically Cheap http://t.co/FomqlE3ZDq Yes, cheap. What will happen 2 cyclical earnings if the economy slows? $$ Aug 25, 2013

 

Central Banking

 

  • Fed’s IG says central bank violated document rules http://t.co/YCtbIbhfAJ Issued minutes of policy meeting a day b4 the scheduled release $$ Aug 30, 2013
  • Did Fed?s Forward Guidance Backfire? Paper Says Probably http://t.co/C4Ew7T2AXR The idea that clear Fed communication works is unproven $$ Aug 25, 2013
  • Summers as Obama Voice of Authority Rides Car Rescue in Fed Race http://t.co/EKKOnRhvq1 Good piece on y Obama may pick Summers 4Fed Chair $$ Aug 25, 2013

 

Wrong, Etc.

  • Wrong: CLO Rule Aimed to Pass Retention to Banks Won?t Work, RBS Says http://t.co/KkQQ8l2lqw Will shrink the # of issuers, that’s not bad $$ Aug 29, 2013
  • Bad title: Why Is Vladimir Putin Acting So Crazy? http://t.co/ILtxIFNOSO He’s acting rationally in response to changing conditions $$ Aug 29, 2013
  • Wrong:Will Obama Make the Fed Even Worse? http://t.co/YZblnIKzOe Not well argued. More about his view $$ policy is 2 tight, less about Obama Aug 27, 2013
  • Sort of: The Strong Case for Optimism About US Growth http://t.co/5LJgQuli4v Except it is optimism after 5 more years of deleveraging $$ Aug 27, 2013

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Retweets, Replies & Comments

  • RT @EddyElfenbein: Happy 83rd Birthday to Warren Edward Buffett @WarrenBuffett. The Dow was at 240.42 eighty-three years ago. Aug 30, 2013
  • #FollowFriday Thanks @ReformedBroker @pelias01 @researchpuzzler for being top influencers in my community this week 🙂 Aug 30, 2013
  • Thanks @OGMarcusC @Metalbanker for being top new followers in my community this week 🙂 | insight by http://t.co/sern3wLA13 Aug 30, 2013
  • @ledbetreuters If you had your own website, & had a Google Page Rank over 5, u would get around two of those per week. Very pesky. Aug 30, 2013
  • RT @azizonomics: Nobel War Prize Aug 30, 2013
  • RT @ianbremmer: Knock knock. Who’s there? The international community. The international community who? Precisely. Aug 30, 2013
  • RT @treehcapital: Yet another reason to love New Zealand @pkedrosky: New Zealand bans software patents http://t.co/6ah7N84QtA Aug 29, 2013
  • Thanks @researchpuzzler @AndreCimini for being top engaged members in my community this week 🙂 | insight by http://t.co/sern3wLA13 Aug 26, 2013
  • @alisonforns And I see the glass as 70 fewer than 140. What a wonderful world! Aug 26, 2013
It’s Not What You Earn, It’s What You Keep

It’s Not What You Earn, It’s What You Keep

Posted on by David Merkel

I like questions from readers, if they are general enough for a blog post.? Here’s one for tonight:

Mr. Merkel,

Following reading your blog here:

http://alephblog.com/2013/01/30/how-to-become-super-rich/

It occurs to me that attaining money in the first place is only half the battle.? A well known fellow among engineers; Nicolai Tesla was great at this.? He made many millions in his life.? He also constantly reinvested most of his income into new inventions and new ideas.? When he died, he was pretty much destitute.

Starting a gas station requires about $300,000 ($150-200k to buy the store/land, 40k to furnish the store, 40k to buy the gas) in startup capital.? In technology, and in software; you can start making money with a good idea and next to no start-up capital… assuming you don’t get crushed by a larger company in the process.

How do the super rich store their massive income?? How do they invest it?? Buying up ever more companies and taking their profits off the top?? What is a minimum threshold amount of money that you need to start to do this?? Can you recommend any good books?

There are several classes of assets that the wealthy like to preserve their wealth.? Here are some examples:

  • Real Estate
  • Municipal Bonds
  • Businesses in necessary industries that throw off a lot of cash flow.
  • Businesses in which they have significant inside knowledge, and can continue to benefit from the knowledge.
  • Occasional equity investments in private ventures that seem promising.

After a certain amount of wealth is acquired, intelligent wealthy people tend to turn to things that have predictable cash flows, rather than take a large amount of business risk.? They’ve made their fortune.? Now it is time to conserve it, and receive what some consider to be rents — passive income that comes with little volatility.

Even Goldman Sachs did this with excess profits, buying safe securities, and throwing them into the BONY box. [BONY == Bank of New York, now BNY Mellon]

In essence, the wealth is converted to ownership in what is likely to be a growing income stream.? What is not used is reinvested.? That is how wealth is preserved during the life of the wealthy.

As for books, you can look at “The Millionaire Next Door,” and its series. Also, Rich Like Them.

But remember, not all rich try to preserve their wealth.? Some lose it through over-consumption, and others through bad investments.? The investments that I list above require a degree of humility, and thus, only wise rich people will follow such a strategy.

The Fed Needs Valuation Actuaries (and More Steel in the Spine)

The Fed Needs Valuation Actuaries (and More Steel in the Spine)

Posted on by David Merkel

I reviewed the following report from the Federal Reserve to Congress today, and found it disappointing.? From my prior experience as an actuary, and the time that I spent on the asset-liability committee of a small bank, I know that? the banking industry is far behind the life insurance industry on risk control.? The Fed would have done far better to have studied the works of the Society of Actuaries and the National Association of Insurance Commissioners, and learned from their efforts.

Now, I know that the contingencies of banks are far less predictable then those of life insurers.? Further, life insurers have long liabilities, whereas the liabilities of banks are short, and thus, they are more subject to runs.? But liquidity risk management does not play a large role in their document — and this is a severe defect in what they write.? Almost all failures of financial firms are due to loss of liquidity.? The word liquidity only appears once in the document, on page 15.? This shows the amateurish work of the writers.

The Fed focuses on a lot of process issues that don’t matter as much as the substantive issues of discovering forward-looking measures of risk, and changing business processes to reflect those risks.

Here are some examples:

1) Internal controls matter, but it is a rare internal control auditor that can truly analyze a complex mathematical process.? They don’t have the capacity to review those processes, or they would be doing it and earning far more.

2) Risk identification is important, but the Fed document would have not helped in 2007-2009.? How do you detect risks that have (seemingly) never happened before?? Further, if you do detect a major problem that has happened before, and it would impair some very profitable businesses, why do you think management will kill profits to appease your lunacy?

3) Governance is important, but the board gets data so late that it is useless.? This is not worth bothering with.? Management has to do the job here.

4) The language on capital targets is weak, and allows the banks way too much latitude in performing their own calculations.? The Fed needs to be far more specific, and prescribe the scenarios that need to be tested.? It need to prescribe the loss severities, asset class by asset class.? It needs to prescribe the correlations, if any, that can be used in the models.

5) The document does not speak of ethics.? Valuation Actuaries do the same work on a higher level, and they have an ethics code.? That may occasionally make them oppose the management team that pays them, but it is a necessary check against managements trying to manipulate results.

6)? The piece spends too much time on the dividend policies of bank holding companies, and no significant time on the abilities of the subsidiaries ability to dividend to the bank holding companies.? The proper focus of a bank regulator is on the health of the operating subsidiaries.? Who care if the holding company goes broke?? Big deal, at least we protected depositors.

Banking regulators should adopt the same policy as insurance regulators.? Outside of ordinary limits, they can deny any special dividends from subsidiaries to the holding company.

7) The piece does not get forward-looking estimates of risk.? On new classes of assets, you don’t have historical data to aid in estimates of risk.? At such a point, one must look at similar businesses that have gone through a failure cycle, or do something even more difficult: do a cash flow model to estimate where losses will fall if asset values decline for an unspecified reason (okay, no more ability to buy…)

8 ) Macroeconomic factors rarely correlate well with the factors that lead to losses on assets.? Most of that effort is a waste.

9) As Buffett said (something like): “We’re paid to think about things that can’t happen.”? This is why the Fed has to specify scenarios, and be definite.? The mealy-mouthed language of the document can be gainsayed.? Life Actuaries have better guidance.

10) So all of the banks did not pass the mark.? With the vagueness of the guidelines, no surprise.? Let the Fed put forth real guidelines for bank stress tests, and let the banks scream when they get them.? Better to have slow growth in the banking sector than another crisis.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Companies & Industries

 

  • Odyssey Hits Wall as Honda Redesigns Minivan to Ace Test http://t.co/6VyK2N2EcO $HMC goes all out to reduce crash injuries 4 2014 Odyssey $$ Aug 16, 2013
  • Fairholme Fund May Increase Bet on Fannie, Freddie http://t.co/EOj8Z9SCzg BB reopens fund 2 get more buying power 4 F&F. Wouldn’t do it $$ Aug 16, 2013
  • Warren Buffett Stake in Suncor Energy, Much More Than It Seems http://t.co/ULDMXqYAnt $SU will be producing high cost oil 4a long time $$ Aug 15, 2013
  • Mall Owners Entice Hispanic Shoppers http://t.co/k42J96Nhxc Temporary stopgap 4 malls being hollowed out by retail over the internet $$ Aug 15, 2013
  • Losing Faith in Gold From Ghana to Vancouver Proves Rout http://t.co/K6VcC7Duyj More high cost mines come out of production as gold falls $$ Aug 15, 2013
  • The iCahn Effect: Apple’s Market Cap Jumps by $17B After Tweets http://t.co/8qb0rUWjCR Don’t c how $1B should move a stock $17B $$ $AAPL Aug 14, 2013
  • Y Food Companies Are Fascinated by the Way We Eat http://t.co/NhIRtprRWj Do u like 2 chew, crunch, smoosh or suck? Food companies study u $$ Aug 14, 2013
  • Financials near to regaining S&P 500’s top spot http://t.co/fgSKGOrfyC We do not learn, we do not learn, we do not learn, we do not learn $$ Aug 13, 2013
  • Endurance Welcomes Fred Cooper 2Head US Financial Institutions Insurance Practice http://t.co/XpQcxwYwJS Picking up nickels… $$ FD: + $ENH Aug 13, 2013
  • Heinz announces layoffs in Pittsburgh and Canada http://t.co/VG3WI8OTfs Now that the merger has closed, the cost rationalization begins $$ Aug 13, 2013
  • Funny in a way: pricing rationality & profits flow to hard disk makers once the industry consolidated down to three players $$ Aug 13, 2013
  • WD? Founds New Storage Association To Promote The Critical Role Of Magnetic Storage Technologies http://t.co/4jKYDyGGb2 FD: + $WDC $$ Aug 13, 2013

 

Rest of the World

 

  • India Shares Slump, Rupee Sinks to Fresh Low http://t.co/cfEnRd5EjQ Central Bank tightens credit conditions- Rupee still falls & stocks2 $$ Aug 16, 2013
  • How Mexico Ended Political Gridlock With a Pact http://t.co/GjNEfA0Ela How the PAN & PRI managed to work together & get most mutual goals $$ Aug 16, 2013
  • What Obama Misunderstands About Egypt http://t.co/UAKXAQBOPs No one worthy of support here, as Egypt slides into a situation like Syria’s $$ Aug 16, 2013
  • Cayman to Singapore Gain as Rules Stump Clinics http://t.co/giudbhHATR Medical Tourism looks elsewhere as India makes things hard $$ Aug 14, 2013
  • Petrobras Downgrade Looms as Slump Sinks Rating Outlooks http://t.co/EpRahHggSF Brazilian corporate sector got too aggressive w/debt $$ $PBR Aug 13, 2013
  • Death of 75-Year Monopoly Can?t Come Soon Enough: Mexico Credit http://t.co/wqfnynnYkP PEMEX monopoly lasts 75 yrs, dies in a few weeks? $$ Aug 13, 2013
  • Japan Inc. Profit Doubles to Add Support to Economic Rebound http://t.co/xv5dPxlRHO Sends $$ from consumers 2 exporters 2 invest abroad Aug 13, 2013
  • Mexico Plans Oil Reserve Sweetener to Lure Exxon, Chevron http://t.co/Ol0sGlse9h Will allow companies 2count reserves from profit-sharing $$ Aug 14, 2013
  • Buffett-Style Dinner Auctions Lure Chinese Seeking Just Society http://t.co/7dK9W52Yhe Long article on odd business seeking a freer China $$ Aug 14, 2013
  • What Brazilian Slowdown? Petrobras Maxes Out Refining Capacity&Imports Oil2Meet Demand http://t.co/0FsI0V6V27 $PBR Milked by Brazil govt $$ Aug 13, 2013

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Bond Markets

?

  • Confident Consumers Step Up Their Borrowing http://t.co/QkD3Xss4NS Auto Loans Post Largest Gain in 7Yrs, as Total Consumer Debt Declines $$ Aug 16, 2013
  • California Sells $5.5B in Bonds http://t.co/TbUGTpmTk7 Better fiscal mgmt, maybe, at least it is not Michigan. Liquidity is abundant $$ Aug 16, 2013
  • Muni Investors Make Michigan Pay http://t.co/zCWMx5Ba2a To get a muni deal done in Michigan, you need extra yield & guarantees/covenants $$ Aug 15, 2013
  • Summer Lull Draws Investors to Riskier Debt http://t.co/08H0vfFj1b Feels like time to begin peeling back credit risk $$ Aug 13, 2013
  • Bond Hubris Overwhelms Fed in Riskiest Credit-Market Sectors http://t.co/WUKgfpse77 No free lunch; Fed’s asset inflation will mean-revert $$ Aug 13, 2013
  • Michigan Safety Net for Boomers Frays on Bankrupt Detroit http://t.co/tTso4JMxTR What happens when u make 2 many promises vs tax base $$ Aug 13, 2013

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Central Banking

 

  • Fed’s Yellen Says Stance on Banks Hardened http://t.co/KZIfgPncaN Yellen tries 2 differ from Summers, but bank regulation was weak 2003-8 $$ Aug 13, 2013
  • Next Fed Head Should Meet the Bernie Sanders/Elizabeth Warren Standard http://t.co/xM9MF71dvM Questions aren’t realistic about $$ policy Aug 13, 2013
  • Yellen, Fischer Among Participants at Jackson Hole This Year http://t.co/MBui5Hfc3y Bernanke not attending as he slips into the shadows $$ Aug 13, 2013
  • Rand Paul on Republicans’ Voter Appeal and the Federal Reserve http://t.co/oVdaavHWsj Can we find another Reagan, who united the GOP? $$ #no Aug 13, 2013

 

Market Impact

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  • Hundred-Dollar Stocks Double as US CEOs Dismiss Splits http://t.co/OOmXdpWSrU With trading costs so low, y do we need splits anyway? $$ Aug 15, 2013
  • How to Invest Like Seth Klarman http://t.co/JDxW9VbROs Easier said than done. Who has the conviction 2 sit on $$ when opportunities r poor? Aug 13, 2013
  • Greater &lesser rotations http://t.co/XZ6D4CgIZq “no evidence that retail investors r very overweight bonds or very underweight equities” $$ Aug 13, 2013
  • Will Mom and Pop investors blow it again? http://t.co/95lZYtIZ6u @BrettArends on retail $$ coming back into stocks; time 2b careful Aug 13, 2013

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Politics & Policy

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  • What We Lose if We Give Up Privacy http://t.co/ZOddurR51k When 4th Amendment rights erode, 1st Amendment rights follow, eg, free speech $$ Aug 16, 2013
  • Free Work Entices Businesses to Hire Long-Term Unemployed http://t.co/Lhemn5JIWp Try b4u buy lets employers figure out who they like $$ Aug 15, 2013
  • Problems With Authority http://t.co/JjIgnIJVEh Obama ignores unusual writ of mandamus, which compels the govt 2fulfill a legal obligation $$ Aug 14, 2013
  • Everything you know about immigration is wrong http://t.co/UpHiI0Wwfd Militarizing the border did not stop the flow in, did stop flow out $$ Aug 13, 2013
  • Encryption App Silent Circle Shuts Down E-Mail Service ‘To Prevent Spying’ http://t.co/95KCJt80mH Destroying data 2 preserve secrecy $$ Aug 13, 2013
  • Eric Holder Owes the American People an Apology http://t.co/07JtmV95QA Vastly overstated the efficacy of mortgage relief programs $$ Aug 13, 2013

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Housing

 

  • Report: Half of All Homes Are Being Purchased With Cash http://t.co/p9GF4dOBUz Good sign. More equity means greater sustainability $$ Aug 15, 2013
  • Baltimore Foreclosures Surge Again as Legal Logjam Breaks http://t.co/xphbxvRXjv Foreclosures take longer 2work out in judicial states $$ Aug 15, 2013
  • Why Home-Price Growth Will Slow http://t.co/IZaE08udfI Prices up, mortgage rates up, fewer distressed homes available 4 sale $$ Aug 13, 2013

 

Other

 

  • Mom, Dad, Sorry I Was So Expensive http://t.co/VakZSkmE3r If u think having children is expensive, imagine the $$ of a society w/out them Aug 15, 2013
  • DNA Sequencing of Tumors Brings Hope of New Lung-Cancer Drugs http://t.co/YRul3Gfiva Costs high, distinguishing between diff cancers worx $$ Aug 13, 2013
  • Companies Ease Up on Non-Compete Agreements http://t.co/iEhtgQ7qjq Restraint of Trade laws also make it difficult to enforce non-competes $$ Aug 13, 2013
  • Overhaul Proposed for Annual Audit Reports http://t.co/8LAgJf5rrU Could b good 2 get past the the present binary pass/fail $$ Aug 13, 2013
  • Stocktwits ? Happy 5th Anniversary http://t.co/AQ8vI1kOsC @howardlindzon extols efforts made as they r the premier social investing site $$ Aug 13, 2013
  • Browser wars: Chrome rules the web http://t.co/QoGqVlVNcI The sun never sets on the Empire of Google’s Chrome; IE dying, Firefox choking $$ Aug 13, 2013

 

On Fiduciaries

  • On brokers as fiduciaries, choose: mixed advice, paid for by commissions, best advice, but u have to pay more 2a fiduciary, or no advice $$ Aug 13, 2013
  • You Can’t Afford Your Broker, at Any Price http://t.co/C46ndiTx6U by @asymmetricinfo on holding brokers 2a fiduciary standard $$ Aug 13, 2013
  • Look Who?s Locking Horns Over Retirement Accounts http://t.co/xSRFtbFndD @jasonzweigwsj tells us 2 act as our own fiduciaries or hire one $$ Aug 13, 2013

?

Wrong

  • Wrong: Don?t Kill Fannie Mae http://t.co/JqDk0kNJM5 People forget the incredible losses on prime mortgages when housing prices fell $$ Aug 15, 2013
  • Dumb: Retirees in Enemy Territory Go Door-to-Door on PPACA http://t.co/4xSgHH2qNL Won’t work unless young & healthy sign up on exchanges $$ Aug 14, 2013
  • Wrong: Your mortgage documents are fake! http://t.co/rErbfMzP7B Mistakes procedural justice 4 real justice. U don’t pay, U get foreclosed $$ Aug 13, 2013
  • Wrong: In defense of the 30-year mortgage http://t.co/cc9kgtRJpM Over-investment in housing & levers up the economy, creating fragility $$ Aug 13, 2013

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Replies, Retweets, & Comments

  • RT @TheLimerickKing: QE has not led to inflation It’s now a much worse situation Velocity’s low But risk assets grow So now it’s just wealt? Aug 15, 2013
  • Commented on StockTwits: No, I don’t. Ultimately all assets boil down to their cash flows. This doesn’t change th… http://t.co/xjshS62La2 Aug 14, 2013
  • A shout-out to DarkCloud @p0stk0m for being my 8,000th Twitter follower. Thanks a lot, & thanks to all who follow me $$ Aug 14, 2013
  • @marketfolly @EquityNYC That is a very good point, and I internally noted it, but did not comment. I should have. 🙁 $$ Aug 14, 2013
  • “Congratulations, Howard. Well done, particularly the way you survived Twitter’s $ grab.” -Merkel http://t.co/tOlvvEqy0P @howardlindzon $$ Aug 12, 2013

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Against Government-Subsidized 30-Year Mortgages

Against Government-Subsidized 30-Year Mortgages

Posted on by David Merkel

I don’t think that those who disagree with me are dumb.? It is often that the person in question is bright, but has presuppositions that disagree with mine.? I am for the most part a libertarian.? Thus I don’t often agree with liberals, or the pro-big-business wing of the Republican party.? Most of the time, I also favor regulation of financial companies, because when too many of them borrow short and lend long, something horrible happens to the economy as a whole.

That is the main reason why I think government encouragement of 30-year mortgages should end.? It increases leverage in the economy, and makes it more susceptible to crises.? Societies that have a lot of debt tend to be more fragile.? We forget how certain we were that Fannie and Freddie could never fail.? I was one of the few people that argued the opposite at RealMoney.com.? (Sadly, those posts are lost.)? F&F assumed that there would never be a sustained period where housing prices would fall across the US as a whole.? When prices began to fall, their business model was destroyed, because they were levered very high.

30-year mortgages allow some to buy houses that they should not buy.? If you have to have a 30-year mortgage instead of a 15-year mortgage, you are buying too much house for your income.? We spend too much money as a society on housing, and we take on too much debt as a result, leading to fragile financial systems.? Debt-based systems are fragile relative to equity-based systems.

If there are to be 30-year mortgages, let them be purely private, like Alt-A, Jumbo, and Subprime loans.? Don’t let the government place any guarantee on them.? If we have to guarantee mortgages, do it from 15 years and shorter.? Reduce the amount of leverage in the economy as a whole.? Make the system stronger, against those who think that encouraging borrowing is a free lunch.

What is the cost to my proposal?? Fewer people buy houses, and fewer houses get built.? Good.? We are over-housed already.? Far better that investment should go to production rather than consumption in the US (opposite in China).? We already subsidize mortgage lending through the tax code, which we should eliminate.? Why should we favor one class of borrowing over another?

Let the apartment REITs house people.? They borrow over a wide maturity spectrum, and do not rely on long-term finance.? Loss of government guarantees on 30-year mortgages will not affect them.

Now, I am responding to this article of Mike Konczal.? Here is one thing that he said:

The second [reason] is that providing macroeconomic stability is a legitimate and important function of the government. After the crash, the government had to step in, prevent a banking crisis and run the entire mortgage market after private capital disappeared. As such, the government holds the tail risk of the mortgage market imploding already; why not make this insurance explicit, while also regulating and pricing it?

Sorry, that’s not the way it works.? The Fed provided too much liquidity, and F&F provided too much lending up to 2007.? Now we suffer the bust from having over-stimulated housing demand.? The government rarely makes things more stable; they are pro-cyclical, and make things less stable.? That’s the way politicians are, because no one will oppose a boom.

We need to move to a less-levered system, where debt is discouraged, to create a system that is not fragile.? After two failures due to high debt levels (current and the 1930s), we should learn that high levels of debt lead to economic failure, and move to a system where interest in not tax-deductible, but dividends are.? This will lower debt levels, and our economy will become more stable.

 

Best of the Aleph Blog, Part 22

Best of the Aleph Blog, Part 22

Posted on by David Merkel

These articles appeared between May 2012 and July 2012:

On Distribution Formulas

Most formulas for distributing income from an endowment or a a savings/investment fund are too liberal.? If you want the purchasing power to last, distribute less.

Correlating Risky Assets

How do correlations come into existence with risky assets.? This piece explains.

Simple Stock Valuation

An exploration of Eddy Elfenbein’s simple stock valuation model.

Don?t Become the Market

When any firm becomes the dominant provider of a good or service, it should ask whether it has mispriced.? A veiled critique of JPM’s whale trade in the credit markets.

In Defense of Nothing

Manufacturing is overrated.? We’ve got enough things, now we need services to make our lives richer.

Little Things are Important

When leverage is high, little things failing can lead to large and bad results.

High Profits

Labor is not scarce, so profit margins are high.? Will that last forever?? No, but it might be a while.

23,401 Auctions

391 Auctions

A pair of pieces suggesting that the markets could be better off if we held auctions once a second, or once a minute.

The Rules, Part XXXII

Dynamic hedging only has the potential of working on deep markets.

Arbitrage pricing can reveal proper prices in smaller less liquid markets if there are larger, more liquid markets to compare against.? The process cannot work in reverse, except by accident

The Rules, Part XXXIII

When politicians don?t have answers, they blame speculators, financiers (Wall Street), or foreigners.? They do anything to take the spotlight off their culpability or ineptitude.

Aim for the Middle

Very basic advice that tells you that the best returns come from taking moderate risk.

Works if Small, Fails if Large

Another bogus theory of asset allocation that works today, because markets favor it, and not enough people are using it.

Strong Hands

On the value of long-term investors holding stocks that you hold.

Logical Links

If there are a lot of links in a chain of reasoning, it is likely to be wrong.

Modified Glass-Steagall

I suggest a number of reforms that would be more effective than reinstating Glass-Steagall.

Don?t Blame Money Market Funds

On the hypocrisy of the SEC and the banking regulators

Do Insurance Stocks Do Better than Average Over the Long-Run?

The answer is probably, but not certainly.? Really, it is a mess.

On Life Insurance and Life Reinsurance

Explains why I like the life reinsurance oligopoly

On Bond Ladders

The most robust strategy for interest rates; always second-best, and never the worst.

On Internal Indexes, like LIBOR

An Analysis of Three-Month LIBOR 2005-2008

On Floating Rates

In most scandals, not enough attention is paid to those who should have been questioning the situation and did not.? There were parties angling for higher LIBOR and lower LIBOR.? Anytime you borrow or lend using an index, you assent to the method of the index.? What, you didn’t analyze it?

The Failure of Government-Provided Prosperity

The government has almost no control over prosperity, and yet it tries to take credit for it, and ends up ruining prosperity through deficits and loose monetary policy.

Grow Embedded Value

The main idea in investing is finding investments that will compound your money at an above average rate, with a margin of safety.

The Education of a Mortgage Bond Manager, Part I

The Education of a Mortgage Bond Manager, Part II

The beginning of my eight-part series on mortgage bonds.? I did it well for three years.

Packages! Packages!

A tale of my younger investing days, when I would mail companies for data.

Missing Earnings Estimates

Why occasional earnings misses are desirable.

Forget Your Cost Basis

All good investment decision-making is forward looking.? Whether you are buying or selling, it doesn?t matter where prices have been in the past.

Concentrated Interest

This piece generated a lot of heat, but I still stand behind it.? The concentrated interest of a profit motive is a good thing, and all of the government services do not affect what you have done at all.? The entrepreneur is a hero, whether in business, government, or elsewhere.

Redacted Version of the July 2013 FOMC Statement

Redacted Version of the July 2013 FOMC Statement

Posted on by David Merkel
June 2013 July 2013 Comments
Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace. Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Shades their view of past GDP down.
Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. No change
Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Shades their view of housing down.? I?m sorry, but balanced budgets promote growth, because economic actors don?t fear their taxes rising in the future.? Also, in Keynesian terms, any deficit is stimulative.
Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. No change, and not true.? TIPS are showing rising inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.5%, up 0.25% from June.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. No change.

Emphasizes that the FOMC will keep doing the same thing and expect a different result than before. Monetary policy is omnipotent on the asset side, right?
The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. No change.
The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term. CPI is at 1.8% now, yoy.? It may be closer than they think.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. 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. To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. 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.

Does not mention how the twist will affect those that have to fund long-dated liabilities.

Wonder how long it will take them to saturate agency RMBS market?

Operation Twist continues.? Additional absorption of long Treasuries commences.? Fed will make the empty ?monetary base? move from $3 to 4 Trillion by the end of 2013.

 
Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. No change.
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will closely monitor incoming information on economic and financial developments in coming months. No change. Useless comment.
The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change.
The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. No change. Vacuous.
In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives. No change
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. No change.

Promises that they won?t change until the economy strengthens.? Good luck with that.
In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. Not a time limit but economic limits from inflation and employment.

Just ran the calculation ? TIPS implied forward inflation one year forward for one year ? i.e., a rough forecast for 2014, is currently 2.20%, unchanged from May.? Here?s the graph.? The FOMC has only 0.30% of margin in their calculation.

 
In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. No change
Voting against the action was James Bullard, who believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. Bullard made his point last month, and sits back with the majority.

George continues to make her point that is the same as mine in my piece Easy In, Hard Out; that the Fed may have greater problems as a result of its abnormal policies, whatever they do in the future.

?

Comments

  • This FOMC Statement was close to a nothing-burger.? They try to take the deflation boogeyman off of the table with words, and no proof.? All the same, they shaded down their views of housing and GDP.
  • Current proposed policy is an exercise in wishful thinking.? Monetary policy does not work in reducing unemployment, and I think we should end the charade.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise in long rates.? The Fed is playing with forces bigger than themselves, and it might just be dawning on them now.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
The Rules, Part XLVIII

The Rules, Part XLVIII

Posted on by David Merkel

If an asset-backed security can produce a book return less than zero for reasons other than default, that asset-backed security should not be permitted as a reserve investment.

Compared to most of my rules, this one is a little more esoteric, so let me explain.? Reserve investments are investments used to back the promises made by a financial institution to its clients.? As such, they should be very certain to pay off.? In my opinion, that means they should have a fixed claim on principal repayment, with risk-based capital factors high enough to take away the incentive invest too much in non-investment grade fixed income claims.

Other assets are called surplus assets.? There is freedom to invest in anything there, but only up to the limits of a company’s surplus.? After all, surplus assets are the company’s share of the assets, right?

If I were rewriting regulation, I would change it to read that only “free surplus” is available to be invested in assets that do not guarantee principal repayment.? Free surplus is the surplus not needed to provide a risk buffer against default on the reserve assets.

But back to the rule.? I think the reason I wrote it out 10+ years ago was my objection to interest only securities that received high ratings, despite the possibility of a negative book yield if prepayments accelerated, and they were rated AAA, and could be used as reserve assets with minimal capital charges.? Buying an asset that can lose money on a book basis for a non-default reason is inadequate to support reserves.? (This leaves aside the ratings’ arbitrage of interest only securities, where defaults hit the yield.? Many have negative yields at levels that would impair related junk rated securities)

This can be applied to other assets as well.? Reverse convertibles that under certain circumstances can be forcibly converted to a weak preferred stock or common stock should only be allowed as surplus assets.? Risk based capital formulas should consider the greater possible risk and adjust required capital up.

Now, maybe this is a rule for another era.? Maybe there aren’t as many games being played with assets today, but games will be played again — having some sort of rule that stress-tests securities to see that they will at least repay principal (leaving aside default), would prevent a certain amount of mischief the next time Wall Street gets creative, putting other financial companies at risk in the process.

The Rules, Part XLII

The Rules, Part XLII

Posted on by David Merkel

During a panic, it is useful to reflect on the degree to which the real economy has been driven by the financial economy.? In the Great Depression, the degree was heavy; in the seventies, it was light.? Today, my guess is that it is in-between, which makes it difficult to figure out the right strategy.

Again, this was written in 2002 or so.? As I posted last night, the banks were in relatively good shape then.? I made a lot of money for my clients buying bank floating rate trust preferred securities at ~$80.? There was no security that we did not clear at least $10 on, and most cleared $20 within a year.? One even went from $68 to $100, plus a healthy coupon.? In bond terms those were a series of home runs.? As an aside, as a bond investor, I focused more on net capital gains than most, and that helped us in a rocky era.? I often gave up current income to gain the potential for capital gains, which was the opposite of most of my competitors.

So in 2002 it was reasonable to buy banks as the willingness to supply of credit grew.? But there are limits to how much credit you can have in an economy without things getting screwy.? An economy with too many promises to pay becomes inflexible; far better to finance more of the economy with equity, but that requires a Fed that works properly, like it was under Eccles, Martin and Volcker.? Under men of less courage, like Bernanke, Greenspan, Burns, Miller, Crissinger, and Young, it simply paves the way for asset bubbles and price inflation.

In 1929 and 2008, though, it was relatively easy to know that the financial economy had grown too large for the real economy.? Total debt to GDP levels were at records.

Or think of it from this angle: in 2004, I was recruited by another financial hedge fund to be their insurance analyst.? I talked with them, but ultimately I refused, because I felt the boss was probably less competent than my current boss.? A major part of his presentation was how amazing the outperformance of financial stocks had been over the prior 10 years, implying that it would be the same over the next 10.? That outperformance was not repeatable because the capital of the banking and shadow banking industries had gotten so large that there was no longer any way that they could extract a high return out of the rest of the economy.? As it was, the effort to do so made them take on asset risks that killed many companies, and should have killed many, many more, had economic policy been handled properly.

This is one reason why my long only portfolio was so light on financials, excluding insurers, going into 2008.? I sold the last of my banks in 2007, realizing Europe would be no safe haven.? I retained one mortgage REIT that cratered as repo fell apart, teaching me a valuable lesson that I had bought something cheap, but not safe.? That was my only significant loss during the crisis starting in 2007-2008.? Repo funding is not a safe funding source during crises, and this is something that is not fixed from the last crisis, along with portfolio margining, and a few other weak liability structures.

With respect to the eras starting in 1929 and 2008, the key concept is debt deflation?? When there are too many debts, there will be too many bad debts.? That is the time to only only companies with strong balance sheets that will not need to refinance under any conditions.? That eliminates all banks and shadow banks.

I can’t guarantee that we are past the crisis, because we haven’t seen what will happen to the economy when the Fed starts to lessen policy accommodation, much less tighten.? As it is, for the most part, I not only own companies that are cheap, but primarily companies that are safe.? Value investing is “safe and cheap,” not just cheap.? This applies to financials as well, but many value investors lost a lot of money on financials because they ignored credit quality near the end of a credit boom.? Many credit-sensitive companies looked cheap near the end of the 2007, but they were cheap for a reason — they were about to get pelted by a ton of losses.

As an aside, do you know how hard it is to get a value manager to short something trading at 50% of book value?

I know how tough that is.? I’ve been through it.? He would not bite.

The company had asset risks as well as liability risks.? I extrapolated the liability cash flows to realize the long-term care? policies the company had written would likely bankrupt them.? But when the boss came to me pitching it as a long because one his buddies thought it was dirt-cheap, I uttered, “Gun to the head boss, I would tell you to short it.”? Reply: “But it’s trading at half of book value.” Me: “Book value is misstates true economic value.? Can’t say for certain, but I think this one goes out at zero.”

As it was, we did nothing, and the stock, Penn Treaty, did go out at zero. (There was one small positive out of this, I did convince the private equity arm not to fund a competitor in long-term care.)

Back to the main point.? Have a sense as to the financial economy.? This will probably only happen once in your life, but that time is crucial.? If there is a financial mania going on, move to safety, and reduce exposure to credit-sensitive financials.? It’s that simple, but to most value investors who invest in seemingly cheap financials that is a hard move.? Remember, safe comes before cheap in value investing, and that means questioning asset accrual items.? Financial companies have that in spades.

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