25 April 2013

Down the Rabbit Hole

Trifecta. Three's a crowd. Win, place, and show. Three strikes, and you're out. Could be worse; there's a fourth item I'm too lazy to delve into.

So soon, you forget, eh? Today's reporting demonstrates that The Powers That Be still don't get it. All their quants doing all their voodoo (I happened to find my way, yet again, to Salmon's piece on Li; so should you), and they all refuse to accept the obvious.

Buried in the back page of the piece is The Truth:
Under them, a borrower's overall monthly debt payments cannot exceed 43 percent of personal income.

In his study, Professor Quercia of the University of North Carolina found that loans that complied with those rules defaulted at a relatively low rate during the housing bust. About 5.8 percent of them went bad, irrespective of how much the borrower put down.

This is The Truth, since it's the converse of what's shown in Viagra in the home: you can't have increasing home prices in a state of stagnant (or declining) median income without some serious fiddling going on.

The argument that down payment makes a difference is a joke. What matters is debt load. The subprime ARMs, in fact all contractual ARMs, would still have exploded irregardless of down payments made. Push up the house vig after two or five or seven years, and the mortgage holder sinks. Unless his/her income has increased concurrently; but, of course, that hasn't been happening for years. Builders, and perhaps lenders, want house prices to always grow, since that's how they continue to make mo money.

Arguments to the contrary, and there's a plenty of them discussed in the piece, pushing the envelope on affordability never ends well. The creation of the various ARMs was not at the behest of home buyers, but of those on the other end(s) of the process. Builders preferred to make 4,000 square foot McMansions. Banks preferred them as well, if only for the larger fees that higher prices brought. In order to accomplish this, however, a way to move folks into mortgages they couldn't have afforded under The Olde Rules necessitated making some new rules. And so it was.

Fiddling with down payment levels won't make much difference, and then not necessarily positive for the economy. The evil part is the ARM. ARM is fine and dandy during periods of macro-inflation; wages lead/lag prices, but move closely enough in concert that the "real" cost of the mortgage stays more or less level. In these (semi-)deflationary times, contractual ARMs (where the rate ratchets at aging points irregardless) will fail. (If there're any who still think such never actually existed, read this.) The only serious avenue is to outlaw contractual ARMs. Prime adjusted ARMs are nearly as bad, when the economy is as out of whack as it is today.

That Giant Pool of Money is still out there, looking for a "risk free" sinecure paying 10%. It ain't gonna happen, but they'll keep trying.

22 April 2013

Kids Say The Darndest Things

Turns out, I'm not the only blatherer addicted to quotes; both prophetic and profane.

This first is found on the R-blogger page.

While this is the first's inspiration.

I think it safe to say that both are willing to cast a jaundiced eye at econometrics in the field. Early on in my professional existence, I concluded that the econometrician's fundamental problem is that their data, by and large, is acquired through begging and borrowing. While I have issues with psychometrics, at least some part of the field generates its own data. To paraphrase Bill Parcells, "If they say you have to make the meal, at least have the authority to buy the groceries."

Neither has the chutzpah to put quotes as the introduction to the site, but someone has to blaze the new trial.

21 April 2013

Shilling For Shiller, Part The Second

Here's the link for Shiller's second column on the housing problem.

I find, on the whole, the column both irrelevant and wrong headed. Irrelevant to explaining the motivation for the Great Recession, which was the flood of The Giant Pool of Money to "risk free" returns into "nearly risk free" housing in the wake of Greenspan crashing Treasuries. While the history comports to what I understand it to be, it offers no further insight into the 2000's conflagration.
Fundamental factors like inflation and construction costs affect home prices, of course. But the radical shifts in housing prices in recent years were caused mainly by investor-induced speculation.

Here is where Shiller starts to go off the rails. Land speculation, as described in the column, has nothing in common with the run up to The Great Recession. The exotic and toxic mortgages, created for the explicit motivation to create more high quality and high value instruments that were "nearly risk free", weren't being scarfed up by Uncle Bill's House Builders, but by segments of The Giant Pool of Money. Not individuals, but corporations, were being scammed. Individuals were the pawns in the scam: "yeah, you're only a hamburger flipper, with fries, at Mickey D's, but you can sell it off in a few years and may be actually make a few bucks".
Interest rates have been declining for decades now. Clearly, that cannot continue on the same track for another 10 years, because rates would have to turn negative.

Well, not negative, but it doesn't follow that interest rates must necessarily rise in some future time. There's no theory that demands that interest rate level be cyclical. In the olde days, one could take a course in Business Cycles (and even an easy one for undergrads and a math-y one for grad students). So long as, 1) there remains a Giant Pool of Money seeking returns, and 2) real returns to physical investment continue to fall then we can expect weak interest rates to continue. In economics, there are a few base principles which not even the math-y types can ignore or deny. One of these is opportunity cost, in essence, how I spend my money involves weighing the various ways to use it. For investment decisions, this boils down to finding the best return. While the banksters consider their fiduciary fiddling to be worthy of interest, it doesn't result from real economic progress. For that, one can only turn to real investment. As The Great Recession demonstrated, only if mortgage holders earn more from their employment can they pay more vig. When household earnings stagnate, so must the prices of everything. And everything includes housing.

When real returns to physical investment decline, for whatever reason, the opportunity cost to investors declines in sync. The "risk free" rate of return will "always" be lower than risky investments, but the difference can only compress so much, if at all. It has been found that capital returns are falling, and so long as that continues, the "risk free" rate will stay about where it is.

But, of course, inflation can rise -- and it's easy to imagine that both it and interest rates will rise substantially, creating a bonanza for home buyers who have already locked in low rates.
What bonanza? Rising rates drive down the price of bonds and house prices or any instrument inverse to rates. House prices will stabilize at a real value commensurate with the interest rate, so if you buy now, you're guaranteed to see little to no capital gain when you go to sell. Those that made out like bandits, from a capital gain point of view, were those that bought when interest rates spiked in the late 1970s. Only if one believes the Bond Vigilantes are right, and I stand with Krugman on that, will there be an interest rate spike any time soon. The middle class remains emaciated, all that QE money remains locked up by banksters and corporations, so there's no money falling out of the sky to drive inflation. To the extent that we see inflation, ceteris paribus, it will be driven by supply shortages, notably in resources. Commodities, however, in a story below the fold of Shiller's piece in my dead trees version, documents that such isn't happening.

In the end, I don't see what land bubbles have much to teach us about The Great Recession, or the near term future, amusing as the history might be.

19 April 2013

A Bit More R & R, Time to Giggle

In my younger years, when free love was pretty much free, there was the adage: "Herpes, the gift that keeps on giving". Well, our friends R&R have become an economic herpes virus. I love it! While it isn't a Liberal Attitude to pile on simpletons, this is one case where I'll play the Social Darwinist card.

Another Ummie has filleted them, this time taking into account most of the considerations I've mentioned earlier.
This pattern is a telltale sign of reverse causality. Why would this happen? Why would a fall in growth increase the debt-to-GDP ratio? One reason is just algebraic. The ratio has a numerator (debt) and denominator (GDP): any fall in GDP will mechanically boost the ratio. Even if GDP growth doesn't become negative, continuous growth in debt coupled with a GDP growth slowdown will also lead to a rise in the debt-to-GDP ratio.

Besides, there is also a less mechanical story. A recession leads to increased spending through automatic stabilizers such as unemployment insurance. And governments usually finance these using greater borrowing, as undergraduate macro-economics textbooks tell us governments should do. This is what happened in the U.S. during the past recession. For all of these reasons, we should expect reverse causality to be a problem here, and these bivariate plots are consistent with such a story.

Reality based policy is sooooo inconvenient. Well, if your goal is overall growth of the economy. If you only care about the .1%, then data doesn't matter at all.

18 April 2013

More R & R, I Feel So Much Better

The broohaha over the Reinhart & Rogoff paper impelled me to look for better stats and economics applied to the question of debt and growth. The graphs in the HAP critique showed clearly that the data as presented by R&R isn't quite right. What struck me from the beginning is that R&R proffered the data as cross-sectional, pure of heart. That was self-evidently false. What we have is an aggregation of time-series. There was a bit of handwaving here and there about serial-correlation (d'oh; it's time series) and multi-collinearity (d'oh; global booms, busts, and catastrophes will impact all economies at once). I'm smart, but I didn't believe that I was the first to notice. In the interests of not re-inventing the wheel, I went looking for papers/postings/musings on the R&R paper and mixed cross-sectional, time series analysis.

On my first search attempt, I found this paper, currently in review. It is dated October, 2012 and directly addresses the R&R paper.

From the paper's Introduction:
These results point to a clear policy implication, namely that it is at best misleading and at worst growth-retarding to assume and employ a common debt/GDP threshold across diverse sets of countries at different stages in development.
Finally, we recognise the heterogeneity of the countries in our sample in terms of their level of economic development and provide further insights into the debt-development nexus at the sectoral level, employing data on the agricultural and manufacturing sectors, respectively.
our empirical analysis accounts for dynamics and time-series issues

And the money quote (within the context of the Introduction):
In empirical spirit this study is closest to that of Kraay & Nehru (2006, p.342) investigating debt sustainability and arguing that "a common single debt sustainability threshold is not appropriate because it fails to recognize the role of institutions and policies that matter for the likelihood of debt distress".

Kraay & Nehru is: "When Is External Debt Sustainable?" World Bank Economic Review 20 (3): 341-365.

Unlike R&R, this paper deals with the data head-on:
In Section 4 we discuss the time series and cross-section correlation properties of the data.

Bonzai! It's a thirty page paper, and still not finished, so I'm not going to cut & paste most of here, which I am itching to do. Go and read it. There's a bit of algebra, but you can ignore that if you wish. Their analysis is in reasonably plain English.

In simple terms: they show that Reinhart and Rogoff (celebrated economists!) are simpletons. Some of the critiques make the point that discrediting the data analysis supporting policy doesn't impinge on the policy decision. In the sciences, this is often expressed as: "data doesn't invalidate a theory; only a new theory can do that." For those who disdain reality based governance, I suppose shooting holes big enough to drive a Mack truck through amount to a mere flesh wound.

17 April 2013

But Liars Figure [update]

If you're a policy wonk, or a regular reader of comprehensive newspapers, you're likely aware of the Reinhart & Rogoff controversy. Fact is, I hadn't been paying attention until today's reporting. The deja vu experience is charming; when I was at UMass, there was only Amherst and the economics department was busy purging anybody who wasn't Right Wing micro zealot. Boy howdy!

The report is here.

Of the critiques of the critique, this one appeals. And here's Krugman.

Anyway, was it intentional academic malfeasance? None of the reporting I've read says so. I'm not so nice.

The money quote, from Next New Deal:
They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don't get their controversial result.

If you read through the various reports, the weighting scheme used by R&R comes up as a major source of criticism. In a nutshell, each country is reduced to one number for each of four categories, regardless of how long its data series is.
(HAP note that just adding an additional category, rather than 90+ makes a difference.
... we add an additional public debt/GDP category, extending by an additional 30 percentage points of public debt/GDP ratio--that is, we add 90-120 percent and greater-than-120 percent categories.

What isn't mentioned (in the reports I've viewed), is weights reflecting economy size. Both R&R and HAP treat all economies as equivalent. They certainly aren't.

HAP (page 8):
But equal weighting by country gives a one-year episode as much weight as nearly two decades in the above 90 percent public debt/GDP range.

It's hard to warrant that categorizing the data, particularly in the way they did, is justified. Well, unless one needs to make a case, much as lawyers will selectively pick facts to satisfy a client. This abject disdain for objectivity is the reason I abandoned economics after grad school.

Excel is for cowards. (Props to Bill Simmons; I think I've got it right this time.)

I've spent some time with the R&R paper, and here's the justification they give:
The four "buckets" encompassing low, medium-low, medium-high, and high debt levels are based on our interpretation of much of the literature and policy discussion on what is considered low, high etc debt levels. It parallels the World Bank country groupings according to four income groups. Sensitivity analysis involving a different set of debt cutoffs merits exploration as do country-specific debt thresholds along the broad lines discussed in Reinhart, Rogoff, and Savastano (2003).

And to further note: weighting by base GDP (for some agreed upon time point) by country has the felicitous effect of de-emphazing small economies with small absolute (in the global realm) GDP growths. A $1 gain for $10 looks a lot better than a $2 gain for $50. Or, "it's easier to grow fast when you start out small!" Just ask Apple, subject of another post today.

The thing is, what they've done (with, or without, the Blessing of the World Bank) is binned continuous data. It is incorrect to label this as "weighting", because it isn't. Binning, for these data, do not improve the explanatory power of the data. Furthermore, they all (R&R, and the critiques I've seen) all allow the outlier question to pass unasked. At 30% and 120% (see the HAP paper, figure 3) there are significant outliers, which (just happen to) push the model in the direction R&R's politics demand. It is well known that linear regression is sensitive to outliers. Further proof. Bad dog!

16 April 2013

Dee Feat is in Dee Flation, Part 26

Once again, the Right Wingnuts, gold bugs, supply siders, and monetarists all; are wrong. CPI is deflationary this past month, -0.2%.

The moolah that the Fed is "printing" (it isn't, it's just exchanging bonds for cash; assets don't change) stays with the Morgans, Carnegies, Rockefellers, Chases, and Mellons. Unless, and until, the moolah makes its way into the hands of the lower classes (ain't no middle no more), there won't be inflation.

The Right Wingnuts insist that the issue with the "recovery" isn't lack of demand, yet prices don't move up. There's more supply than demand, that's Econ 101, even at the Fascist Family Home School.

14 April 2013

Reverse Thrusters, Mr. Scott!

A comment on one of these missives, posted in an alternative universe, led me to comment serially. This is the part of the comment which motivated this missive:
The only way to increase the demand for stick built single family housing is to drop the price a lot. Not to mention that boomers will be dieing off soon, and all those reverse mortgages will stuff yet more inventory into the mix.

Which led me to go a lookin' for data on reverse mortgages by year and value. Haven't found same as yet, but I did find a bit scary reporting from last week.
While forward mortgages show a surplus in FHA's reestimate of reserves of $4.3 billion, the reverse mortgage portion shows a loss of $5.2 billion, resulting in the $943 million shortfall, according to FHA.

An actuarial review of the MMI fund in late 2012 indicated the reverse mortgage fund had a negative $2.8 billion economic value; part of more than $16 billion in negative economic value of the fund overall.

There have been a stream of stories about surviving spouses being tossed out of homes when the mortgage holder spouse kicks the bucket; the rules about who can be on the title/deed get convoluted. And, according to some reports, such as this, the Banksters aren't above fibbing a bit.

I wonder: is there yet another Viagra at the home we need to worry about?

Shilling For Shiller

This endeavor began in the idleness resulting from The Great Recession, and took square aim at the silliness of the housing market. In particular the notion the a home mortgage is an investment, whether from the point of view of the homeowner or the buyer of MBSs or CDOs and the like.

Well, today Robert Shiller begins a three column series on housing. While the housing industrial complex has always trumpeted the home mortgage as the bedrock of a family's "investment portfolio", economists not tied to the complex have always made the point that housing (residential) or commercial (offices) don't generate any fiduciary returns. You've read that here more than once.
Here is a harsh truth about homeownership: Over the long haul, it's hard for homes to compete with the stock market in real appreciation.
Housing is an ambiguous investment to evaluate, because a good part of its real return typically comes in its providing a place to live, not in providing dividends paid in cash.

He devotes the last part of the piece discussing changes in technology that have led to declining costs of building housing. There's that old saw, "If cars had followed a cost curve like PCs, a car would cost $100 today"; or thereabouts. Would it make even a bit of sense to "invest" in an "asset" that's going to be cheaper to make next year than it was last year?
By contrast, real home prices should decline with time, except to the extent that households shell out some money and plow back some of their incomes into maintenance and improvements, because homes wear out and go out of style.

Unless, of course, your house is an original Queen Anne or Victorian or some other distinctive antique building, with suitably updated electric, plumbing, and mechanicals of course. Needless to say, but I'll say it anyway, is that improvements in house building technology apply (nearly) solely to new construction, and thus drive the market price per square foot down. Your house's competition for sale will be cheaper, and perhaps better. For myself, I don't want a house with engineered floor joists made of wood chips and glue or space frame roof rafters which have no attic.

There you have it. Stupidity goaded by those who benefit from the stupidity. Perhaps we should have a program so that "No homeowner left behind"?

08 April 2013

Finding Nemo

It must be vexing to be a quant in the financial services industries. On the one hand, you're in the Next Sexy Career: data science. On the other hand, Greenspan and Bernanke and yourselves have shoved a 20 inch long 4 inch wide dildo up your yahoo. That's got to hurt.

What happened? Well, the base cause is wealth concentration. When the few have the most, there's little left to drive real demand for goods and services. Absent real demand, there's no cause to invest in real capital. With a slackening of real capital, the trickle down to fiduciary capital is inevitable. This effect is more obvious in industrial economies, over the last century or thereabouts, than earlier. But, "let them eat cake" has been the crux of the matter for a lot longer.

Unearned income is both a social and economic porcupine. To the extent that the .1%ers demand 10% or so on their amassed moolah, the quants (who are, after all, the braceros in that sector) have to find another way when Treasuries dry up. Before Greenspan cratered interest rates, it wasn't impossible to pull off. Not so much of the moolah had to find a risker home (presaging?). Treasuries were pulling in the mid to high single digits, so only a small part of that accumulated moolah had to be allocated to "risky" assets. Preferably fiduciary assets, since physical assets is something neither the .1%ers nor quants understand all that well. Physics and engineering and real demand for goods are, taken together, mind numbingly difficult to conjure.

With the Fed cratering "risk free" unearned income, the quants looked to the, historically, nearly risk free instrument: the home mortgage. Whether there was (certain Right Wingnuts gainsay) a giant pool of money out there, or not, forcing the interest rate of record to very low values forced all those who depend on unearned income to look elsewhere. So, they did. (The giant pool argument being that the rate would have cratered no matter what Greenspan and Bernanke did, since the giant pool would, in aggregate, have been chasing a fixed field of investments. Supply exceeding demand, drives down the price, which is the interest rate.)

But there is a trickle down unintended (one hopes, at least) consequence: all other forms of reliance on unearned income were just as affected. Your life insurance and health insurance and defined benefit retirement plans (the few that still exist) all began looking for ways to opt out of cratered US fiduciary assets.

What had been the earnings? Here is a compilation.

There are a slew of tables, so I'll just highlight the numbers that speak to me (from table 2.11 $millions):
1970: mortgages - 74,375 stocks - 15,420
2010: mortgages - 366,988 stocks - 1,570,225

As is obvious, a tectonic shift. Put simply: your life insurance policy now depends, more than it ever did, on Prudential's rock solid quants picking the right stocks. And more to the point: your policy depends not on compound interest, but on fiduciary capital gains. You should feel your sphincter tighten rather a lot.

Table 12.2 is instructive. There's a vicious Prudential commercial (actually, a number of versions) on the TeeVee where some "professor" has folks put a dot on a wall, representing the "oldest" person known. These are actors, of course, and it's all made up. This table has life expectancy (from the industry Bible of data; you thought each quant figured this out on his/her own? not really!) at various ages starting in 1900. At birth, it goes from 49 to 78! We're living nearly twice as long! The sky is falling! We must kill off a hoard of old people! Not really.

Social Security was established, circa 1935 (first paid 1937). So the number that really matters is life expectancy, at 65 or 75, then and now (the closest year in the table is 1939).
1939: 65 - 12.8 75 - 7.6
2009: 65 - 18.8 75 - 11.7

So, yes we are living longer, but the sky isn't falling. More to the point, since SS is a *current account* system, having folks living until 65, which is where almost all of those 30 extra years are, means more folks pay in longer. Yes, the Boomers will be something of an extra burden for a decade or so, but after that, it's all gravy.

In sum, the issue comes back to macroeconomics, despite the fact that quants operate in a microeconomic venue (what's the slickest way to make my employer richer?). Both life and health insurance are inter-generational moolah flows; that fact can't be denied. The question of equity is both micro and macro. From a micro point of view: it's a dog eat dog world, and every man for himself. In such a world, insurance is funded solely by individuals' earnings. This is a divide-and-conquer method whose main beneficiary (pardon the pun) is the financial services industry; there are a whole lot more easily divided buyers than sellers. The principle difficulty, aside from outright equity, is that individuals are cornered by the market. If one retired, or wished to do so, around 2008, with only individual assets to support said retirement, well, good luck with that.

It's simply more equitable to remove the luck (good or bad) of the draw from these decisions. Those who are eligible for funding at some point in time ought not to be penalized for macro market conditions that are cratered. Similarly, for those who are elibible at the top of the rollercoaster ride.

Any increase in retirement funding has to come from real investment. As The Great Recession proved to anyone paying attention, fiduciary instruments are merely pass-through monies. Without underlying increases in real incomes (and they can only come from increases in real productivity), the instruments fail. And so they did.

Taking a macro point of view, one comes to a somewhat different conclusion about how to fund insurance programs. Firstly, the income streams are unearned from the point of view the funds; these are fiduciary instruments which have more or less tenuous connection to real world investment. Since both retirement and health exist at the societal level, then one needn't incur the overhead costs of administering a faux investment fund. To be specific: there have been, over the years, assertions that SS is/should be an investment system. It isn't and shouldn't. It isn't because FDR's wonks weren't stupid. And it shouldn't be because it makes no sense. If SS held private stocks and bonds, how would it regulate/police the stock markets? Recall that SS came into existence in the wake of The Great Depression, which was caused by unregulated markets.

If SS held private stocks and bonds, it would be obliged, as a shareholder, to defend Enron and Country Wide and all the other malefactors of the private markets. The current system of "investing" in Treasuries (broadly defined) is a sham, and that's OK. It seems to allay some of the idiots who insist that SS holds their "personal investment". It doesn't, and never did. Also, the notion that Average American in 2010 may/will receive more than s/he paid in, is nonsense. Average American pays for the SS of his/her parents. Would you stiff Mom and Dad, just so you could have an iPhone 7? (You would?) Yes, the Boomers are the pig in the python. And yes, Boomers didn't breed as eagerly as previous generations (well, those who aren't religious whackos, anyway). But we've seen in the last 40 years that productivity has widely outpaced employment. In other words, we don't need no stinkin' babies.

That last is the political meatball. Japan put itself in the mess back in the 1990s, and China, being so much larger, is seeing the effect faster and more pronounced. Society wide insurance demands a society wide (and inter-generational) funding mechanism. Otherwise, it's let them eat cake.

07 April 2013

Sharing in Texas

We live in schizoid Times, New York edition. It appears that, once again, the Editors don't talk with each other. Texas arrogance has been a bete noir since the days of the first OPEC oil embargo, and Texans' display of the "Let the Yankee Bastards Freeze" bumper stickers. Today, it's "Let the Texas Bastards Desiccate". Look it up.

So, what did the knuckleheads do? In the Business section, they review an encomium to the rebel shits.
Texas's laissez-faire mix of weak government, low taxes and scant regulations is deeply rooted in its 1876 Constitution, which was an attempt to vehemently dismantle an oppressive post-Civil War government of radical reconstructionists. Texas business interests flourished after turn-of-the-century legislators passed an early antitrust law, which kept much of its oil and natural resources squarely under local control.

It's also worth noting that Alaska, too, is socialist when it comes to petro resources: each citizen gets a check from the resource haul.

But over in the Review section, is story about water, or lack of it. And Texas's willingness to beggar its neighbors, whether within the US or outside. All of that Ayn Rand shit doesn't mean much if there's no water. And there isn't.
The implications have finally sunk in among lawmakers and business leaders here, who like to boast about the economic appeal of Texas's low taxes and relaxed regulatory environment: no water equals no business. In a state fabled for its everything-is-bigger mentality, the idea of conserving resources is beginning to take hold. They are even turning sewage into drinking water.

Drink shit and bark at the moon.

Let the bastards die.

06 April 2013

You No Longer Interest Me

Another day, more data. Floyd Norris has more on falling interest rates in today's NY Times. Yet more pretty graphs, detailing that it's getting harder to earn money by doing nothing. When I was growing up in a poor but unhappy white trash housing project, the epithet "coupon clipper" had two meanings: the folks who had to use newspaper grocery store coupons in order to eat, and those who lived in the big brick houses off the proceeds of clipping coupons off their bonds.

The fallout from Greenspan's original interest rate cratering continues.
JUNK bonds have never been more popular, even if they no longer deserve to be called high-yield bonds, the more polite description that Wall Street prefers.
At the same time, the yield on such bonds has fallen to the lowest level on record. The Bank of America Merrill Lynch U.S. High Yield index yielded 5.7 percent at the end of the quarter, as can be seen in the accompanying graph. That was down from 6.1 percent at the end of the year, and from 8.3 percent at the end of 2011.

What's going on here is that the moneyed class had gotten used to getting 10% (or thereabouts) on their accumulated moolah risk free. Ah, the soft sofa of Treasuries. Not so much anymore. As explained in recent missives, real returns on physical investment has been falling for some time. Since these returns are the bedrock of capital markets, what happens in the real world of physics and engineering, has a direct impact on fiduciary capital. Real returns on physical investment are the only source of the vig to pay the interest. All those fiduciary and non-productive (infrastructure, real estate) uses have to connect back to some source of increased productivity. Otherwise, it's merely a case of robbing Peter to pay Paul: a zero sum game. The financial services "industry" is just that; taking its profit from the stream of moolah from savers to borrowers. When borrowers use the moolah in non-productive ways, the only way to pay the vig is with inflation puffed up cash. In other words, inflation is a good thing for the crooks.

Anyway, Norris has some (what appears to be) proprietary data, nicely graphed (they're linked to, not in the main body; all in one place in my dead trees version. Ha!). At usual, when moolah floods some sector, returns go down as prices go up. It's just more immediately obvious in bond markets.
Mr. Fridson also noted that nearly a third of the companies that issued high-yield bonds for the first time in 2012 were among the lowest-quality borrowers. "When high-yield managers are under pressure to invest large cash inflows, as they were last year, and when high-yield issuers feel no particular pressure to borrow, the financing window may open to lower-quality credits that would be excluded under other circumstances," he wrote in a commentary published by Standard & Poor's Leveraged Commentary and Data.

What goes undescribed, and likely hidden from public data, is how these high-yield instruments are used. If they're used to build new plant and equipment, in cutting edge industries, all well and good. Not so much.

05 April 2013

I Told You So, Part 4

One of the driving themes of this endeavor is that technological change, and financialization activities in "post-industrial" economies, has led to a long-term, if not permanent, decline in the real rate of return on physical investment. Whatever the finance zealots may say, earnings are ultimately determined by productivity in the real world. (Studies show that "office productivity" suites such as MicroSoft Word/Office have a negative effect.) As humanity bumps up against physics, and population, the opportunity to earn real returns diminishes. Add in the subtractive effect (on aggregate demand) of wealth concentration, and the result is diminished interest rates.

Finding data to affirm, or deny, that thesis has been hard to come by. Until now.
The investment rate (investment as a share of GDP) of mature economies has declined significantly since the 1970s, with investment from 1980 through 2008 totaling $20 trillion less than if the investment rate had remained stable. This substantial decline in the demand for capital is an often overlooked contributor to the three-decade-long fall in real interest rates that helped feed the global credit bubble.

McKinsey isn't a bunch of long-haired left-wing softies. If anything, its reputation is among the more Darwinist in the consultancy world. As it happens, I disagree with the report's grand theme: that emerging countries will push up the demand for capital, and thus interest rates. Again, infrastructure build-out doesn't generate fiduciary returns to pay the vig; that has to come from taxes one way or another. And the only way to generate the vig is improvement in production of whatever these emerging countries have to offer.
But the coming investment boom will have relatively more investment in infrastructure and residential real estate.

For being the smartest guys in the room (or why else would you get hired to "consult"?), the authors are badly disconnected from reality.

As shown in an earlier post, IT (the future of all economies?) payback period continues to extend, which, by inversion, means that real returns decline. Moving moolah into merely fiduciary instruments, as detailed in the report (housing and infrastructure don't generate moolah as return), will only mean that Great Recessions will be generated not only in The First World, but also the Second and Third and so on.