Until recently, Alan Greenspan’s main argument to exonerate himself of responsibility for the 2007-2009 financial crisis has consisted in the claim that strong Asian demand for US treasury bonds kept interest rates on mortgages unusually low. Though he has not given up on this defense, he is now emphasizing a different tack... His new tack is no better than the old tack.
It may appear to be safe for everyone to be on the same side of the boat, but the gunwale is awfully close to the water.
We are growing more concerned by the day by the actions of the central banks. It isn’t just that markets popped and dropped dramatically before and after Draghi’s rate cut, or that any policy seems particularly bad, just that the policies don’t seem to be working great, and are leaving a changed landscape that will need to be corrected, somehow, in the future. We are quite simply concerned that too much faith is being placed in untested theories that may or may not work, or may or may not even be correct.
Bob Shiller is one of the winners of this year’s Nobel Memorial Prize in Economic Sciences, which makes him acutely aware of criticism of the prize by those who claim that economics – unlike chemistry, physics, or medicine, for which Nobel Prizes are also awarded – is not a science. One problem with economics is that it is necessarily focused on policy, rather than discovery of fundamentals. Shiller notes that economics is somewhat more vulnerable than the physical sciences to models whose validity will never be clear, because the necessity for approximation is much stronger than in the physical sciences, especially given that the models describe people rather than magnetic resonances or fundamental particles. People can just change their minds and behave completely differently. But all the mathematics in economics is not, as Taleb suggests, charlatanism.
San Francisco Fed head John Williams - known for his extremely dovish views on monetary policy (and support of record accomodation) - appears to have taken some uncomfortable truth serum this morning. In a speech reminiscent of previous "froth" discussions and "irrational exuberance" admissions, Williams explained:
- *WILLIAMS SAYS POLICY MAY YIELD ASSET BUBBLES, UNINTENDED RESULT
- *WILLIAMS: ASSET-PRICE BUBBLES AND CRASHES 'ARE HERE TO STAY'
- *WILLIAMS: ASSET-PRICE BUBBLES ARE 'CONSEQUENCE OF HUMAN NATURE'
His words appear to reflect heavily on the Fed's Advisory Letter (from the banks) from 3 months ago - warning of exactly this "unintended consequence." This, on the heels of Plosser's recent admission that the Fed was responsible for the last housing bubble, suggests with the black-out period before September's FOMC about to begin, the Fed is sending us a message that Taper is coming - as we know they are cornered for four reasons (sentiment, deficits, technicals, and international resentment).
Can you imagine successfully navigating the next decade ahead with a great system. We have arrived at a juncture that will require major efforts on the part of investors to reshape their investments. You see, we believe that major forces at work will be to the benefit of credits. We propose a structure that removes any debt based investments.
Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).
The assumption that households are doing much better simply because the stock market is up is really a problematic understanding of how wealth is dispersed across the United States. I vividly remember a handful of parties back during the peak of the bubble where people would often quote how much their net worth went up courtesy of the housing bubble. “My home that I bought in the 1990s is now worth over $1 million.” As all of you know, until you sell the home those gains are largely on paper and many did not sell. In fact, many tapped out large portions of that equity and spent it. This is why even with home prices moderately recovering US households still have close to record low equity in their homes. It probably does not help that low down payment FHA insured loans are such a large part of the market encouraging Americans to make the biggest purchase of their lives with very little down. The Fed reported last week on net worth figures and it is worth digging deep into the data.
The market rally has assuredly been more powerful than Morgan Stanley had anticipated, defying the weak fundamentals. Many have said they don’t think fundamentals will matter for the rest of this year. We don’t do heroin. We are sure the period of being high on heroin is “enjoyable.” We had thought that most investors would decide this “heroin” wasn’t worth it. We forgot about what it means to be an addict. Will equities continue to go higher simply because the specter of unlimited liquidity is there or will investors see through to the other side of the “high”? People can’t envision a catalyst to make fundamentals matter, they can’t envision a catalyst for earnings to come down, and they still think the “tradable rally” from positioning and policy will last. It well may last for a while more, but the disconnect from fundamentals can’t last forever. We all know that the current “bad is good, good is good” mentality can’t persist.
Gluskin Sheff's David Rosenberg may be cautious on the outlook for risk assets and cyclical securities over the near- and intermediate-term, but, he notes, change is always at the margin, and it usually starts in the political sphere. Austerity is not some dirty nine-letter word as the socialists in Europe would have you believe. It is all about living within your means and living up to your commitments. There is some good news in the United States with respect to this topic, but the uncertainty over the extent of next year's tax bite is likely to cause households and businesses to pull spending back and raise cash, at the margin, which means the economy won't turn around in time for Mr. Obama. As was the case with Ronald Reagan, just having a clear and coherent fiscal plan will part the clouds of uncertainty and encourage capital to be put at risk rather than sit as idle unproductive cash on corporate balance sheets. In a somewhat stunning sentence from the no-longer-a-permabear, he notes that "The future is brighter than you think", but just in case you are backing up the truck, he adds "this does not mean we will not have another recession, by the way — as we suffer through a deflationary debt deleveraging. I'm noticing a certain degree of despair these days, just as I am getting enthusiastic about the future. Much depends on what happens on November 6th and between now and then we still have the European mess, China hard landing risks and the U.S. debt ceiling issue to confront. Be that as it may, those with some dry powder on hand will be in a solid position to take advantage of whatever forced "panic" selling takes place."
The financial elite - using academe for intellectual cover - want you to believe that markets are efficient, as defined by the Efficient Market Theory (EMT). Neoliberal economic philosophy is based on the belief that neoclassical economic theory is correct. That is, that “markets are efficient”. Wall Street touts markets as trustworthy and infallible, but that faith is misplaced. Gullible US politicians believe that markets are efficient and defer to them. Therefore, US politicians abdicate their responsibility to manage the overall economy, and happily for them, receive Wall Street money. Mistakenly, the primary focus during the 2008 credit crisis is on fixing the financial markets (Wall Street banks) and not the “real economy.” The financial elite are using this “cover-up and pray” policy—hoping that rekindled “animal spirits” will bring the economy back in time to save the status quo. This is impossible because the trust is gone. The same sociopaths control the economy. A Federal Reserve zero interest rate policy (ZIRP), causing malinvestment, and monetizing the national debt with quantitative easing by the Fed, and austerity for the 99% to repay bad bank loans has not worked—and doing more of the same will not work—and defines insanity.
The ascendency of behavioral economics over its “Classical” cousin is one of the more notable effects of the market turmoil of the last five years. Simple constructs like “Every marginal dollar has utility” have given way to more nuanced explanations that incorporate how human beings really make decisions about the tradeoffs between money and deeply held emotions and beliefs. But even with this realization, academia still seems to have a choke hold on the studies that expand our knowledge of this new discipline. Nic Colas, of ConvergEx, adds to the discipline’s canon with some examples of common street scams around the world. The comparisons he makes to recent events in the capital markets are fairly obvious, whether they be failed IPOs or the strategies used by weaker sovereign nations to negotiate with stronger ones. The point here is not to call out anyone as inherent ‘Criminal.’ There are plenty of laws – and diligent regulators - surrounding the capital markets, after all. Rather, the examples here are simply a lens that allows us to examine the nuances of human behavior with greater understanding. As the old saying goes, 'The proper study of mankind is man.' Even when it is a con man. And in the case of behavioral economics, perhaps especially so.
With Citigroup raising the odds of a Greece exit from the Euro to between 50 and 75% in the next 12-18 months, it is perhaps worth reflecting on just what is holding them back and where Europe goes next. There has been and will continue to be much written on the faulty premise or failed-experiment of the Euro and using George Soros' recent less-than-sanguine discussion (at the INET conference as we noted here) of Europe in general (how did they get here? exactly where are they? and what are the scenarios going forward?) Gordon T Long and John Rubino expand on these thoughts in a must-watch-before-you-hit-the-BTFD-button clip this week. If there was a dummies guide to Europe's problems, this is it - plain and simple - and as this weekend's elections perhaps reflect "when you borrow too much money as a nation - you become ungovernable - as there is no painless way out."
Looking back at the carnage created by the bursting of the credit bubble, it’s natural to scratch your head and ask “How did we ever let that happen?”. Behavioral economics exists to answer questions like this. Last week Chris sat down with Dan Ariely, gallivanting behavioral-economics-researcher-extraordinaire, who is breathing new life into this previously obscure field of study. The resulting interview is full of fresh, non-intuitive insights and shines light on how the human brain is often hard-wired for irrational action when it comes to money.
David Wessel of the Wall Street Journal laments the fact that Mr. and Ms. America wrongfully scorn the bailouts of Wall Street. He believes the bailouts saved the world. I think Mr. and Ms. America have it right.