If no one criticizes, no one is listening

I wanted to leave a link to Paul Krugman’s post that references the cycle charts.  Now to be fair he criticized the WSJ not the package itself so I may be stretching for a critic.  The Eichengreen-O’Rourke work is very good and require some fairly heavy data lifting (I’ve trekked around to a couple libraries and haven’t been able to find a good set of League of Nations Monthly Statistic Bulletins) but they are doing draw down chart not cycle charts so by there nature the downturns will be more in-line.  Each methodology is valid but they have different purposed, I prefer cycles for thinking about the economic relationship but draw-down are not a bad way to look at a collapse. 

As an aside: For my select few diligent reader I’m sorry about the weak and infrequent posts of late.  I’ve been given the honor of being a dear friends executor so I’ve been spending all free moments trying to school myself on some legal details.  I’ll be back up and ranting soon enough.

Still have to pick up the dollar

There is a ‘classic’ joke about two economist walking across the campus quad.  They see a 20 dollar bill on the ground and one goes to pick it up and the second prof, stops the first by saying, ‘markets are efficient, if the $20 dollar were on the ground it would already be gone.’  So the first stops and leaves the money there. 

Now I think that the joke is a little harsh toward academics.  Yes sometimes they seem to model for the sake of modeling and want reality to conform to their models instead of the other way around but they do so at their own risk (the better ones try to account for these things and when they don’t they do so explicitly to show the core elements cleanly).  The point of the joke is that the economist fail to recognize the friction in the efficient market or put another way someone has to make the markets efficient (they have to actually pick up the bill). 

What made me think of this was I was looking at an asset and was struck by an unusual event.  The bid (what someone was willing to pay for the asset) was higher than what someone was willing to sell it for.   

Now I don’t know many of the technical details of how various exchanged manage matching across their books but its it important to remember these types of details – even if it, which more often than not may make sense, via a humbling process in the model.

Complication is not new, the question is it worth it

As time passes each age sees themselves (for the most part) on the cutting edge of …fill in the blank.  Whether they are or are not is in many ways debate-able but to be on the cutting edge often requires complications.  Some recent conversations have surrounded the idea of keeping complexity out of certain areas.  How should that choice be thought about? 

Consider that Leonardo Da Vinci stuggled with the concept zero.  Although its still may be a struggle when your going through algrebra in primary school it no longer pushes the great minds of our time.  My point is the because something is complicated doesn’t mean that it should be scraped.

I would suggest considering the following question, ‘does the construction, that happens to seem complicated, have value or is its value derived from the complication itself?’  What do I mean.  For example sales people will use complication to obfuscate the truth while remaining ‘honest’ in order to close a sale.  I was reading something recently where a CMO market participant was quoted as saying, “We think (they try) to obfuscate the risk associated with each one of these tranches. We think it is a kind of deliberate thing on the part of the dealer community to make it very difficult to understand the (securities)” 

I was surprising to see that the quote was from 1993.  If the ‘CMO market participant’ is right and the complication is for the sake of obfuscation then the complication is not (net) valuable.  This makes one reflect, bond basket products have been complicated for a long time, but they haven’t always blown up.  Does complication lead to blow up?  No.  Does complication make blow up more likely? Yes.  Does complication have value? Maybe.  So should these bond baskets continue?  They will need to show that the risk/reward to increased complication is better than it has proven to be so far.

New Recession Chart Book

Update Cycle Chart book is here:

Education and Competition

An interesting study came out of AEI recently called Diplomas and Dropouts.  It took a look at college competitiveness ratings and graduations rates.  (Side note: There is a data problem because transfers are not captured well and thus push down the less competitive schools graduations rates (think, if you get into Harvard, you’re not transferring), but I’m guessing that this doesn’t change the basic picture).  So, what is the basic picture?

As the competitiveness increases so do graduation rate (if you can get into MIT; you can graduate – don’t confuse this with me saying that it is easy), but if you can get into a local community college, I don’t know if you have the skills to graduate or not.  This part is fairly simple.  The more interesting thought and one that requires a little bit more thinking (maybe the paper does the thinking…I’ll admit, didn’t read it just looked at the numbers), is does the distribution of the categories imply anything about the categories themselves?  Does a disperse range mean that the quality of the school are all over the place (or is it just random)?  Of course this is complicated by the fact that you can’t tell the difference – on face – between a 100% graduation rate because the school is a joke or because the school is great at helping their students succeed.

What is behind the dollar fall?

The US dollar has fallen of late and speculation about a dollar collapse driven by expansive monetary policy and fiscal profligacy and facilitated by scared global and domestic investors has started in the rumor mills.  Although this speculation never stopped in some corners and it is not total without basis although I find it hard to see the dollar breaking down without the breakdown of Bretton Woods II which we seem to be returning to rather rapidly.  But that is another story….I want to point out the the recent fall in dollar might possibly be just a return to normalcy (removal of the inverse risk premium), this would match some risky asset markets but it can also be seen when you look and see that the people (at a country level) who scrambled for dollar when the crisis started are paying it back (the dollar loans the federal reserves gave out to foreign central banks are being paid back rather quickly).   (Add this to recent reserve growth and then compare that rate of growth to pre-crisis growth rates…)

Delinquencies driven by mortgage structure…

Came across this chart from the ‘Profits and Balance Sheet Developments at U.S. Commercial Banks in 2008‘  Although the basics of this presentation are well known.  I saw the following chart that I thought was  interesting.  It shows sub-prime and prime mortgage delinquencies by fixed and variable rate.  I find it interesting that variables rates are so much worse than fixed (it would be interesting to know what portion of the delinquencies were driven by resets in interest rates within the variable rate category). 

This divergence is likely -in part- due to the ‘other’  (read junk) being inside of variable category but even if that attribution was accounted for I suspect the breakout would be striking.  Why does this happen, if the choice between the two products is simply a bet on interest rate paths?  Is is that those who can’t qualify for fixed can qualify for variable and if so why?  Is it that the less educated (and thus less robust) are being pushed toward variable rates which pose a different set of risk (which I would argue are riskier for the HHs) than fixed? 

Debt Distribution

The 10 yr bond has given some of us some anxiety over the past few days/weeks.  Admittedly a rally from low 2% to high 3% is big (at least on a change basis…debatable on a level basis, although it would be a high real yield if we descend into a deflation depression what that’s not the baseline expectation at this point).  All this being said what is causing the large fall in U.S. debt (remember a rising yield mean a falling bond price)?  The answer as far as I can tell is awkward auctions.  Where the price for new issuance is not coming in where the market expects them and it is shaking the confidence of debt buyers.  Some people have speculated that China has taken a breather from buying treasury debt to show that they don’t have to do so.  If that is the case, which doesn’t show up on a level basis in the custodial holdings (it could be done via a shift in maturity structure purchasing), and they want to keep their currency policy they have to buy other $ assets.  If they are unhappy with the risk of US treasury bonds its hard to imagine they are happier with – say – equities or corporate bonds.  That being said that could have rock the asset class or debt distribution boat for a few auctions to send a message. 

What would that message be?  In part ‘we want assurance about better fiscal policy/we want to be paid back’  but it is also about the type of debt that is being offered.  The U.S. treasury department has been issuing a lot more 3-5 yr issues instead of bills while bills have appeal to these hyper-risk adverse policy investors.  They are not being given the flavor that they want, thus the boat is rocked.  From the U.S. perspective you can push the 3/5 year debt and risk bumps but you have less roll over risk over the next few years.  I think this is a smart strategy (I’m assuming this is being done explicitly). 

This reality is illustrated in the following chart which show three snap shots of the Federal Debt Distribution (the portion that I’m talking about is the difference between Feb-09 and May-09…2000 is there for other reason). 

Fufill its role

The Federal Reserve came out with a press release today at 4pm.  The long version is linked here.  The short version is: If you are a large U.S. financial institution you will not be able to pay back the government capital until the system is working.  This is great news.  The Federal Reserve Board gave themselves a lot of subjective wiggle room to prevent banks from paying them back.  “Whether a BHC (bank holding company) can redeem its Treasury capital and remain in a position to continue to fulfill its role as an intermediary that facilitates lending to creditworthy households and businesses”  It seems fair to assume that the banks, besides Citi and Bank of America, could pay back that capital with some combination of public capital raising and balance sheet contraction.  This means that there is demand to shrink the capital base of the banking system and the Federal Reserve has it hands on the nozzle controlling that force.  Wha la! A new monetary policy tool, a capital escape value.  Although that was not the point (the point being they didn’t want the banks shrinking there balance sheets and thus induce a deflationary depression just to get out from of the burning wrath of congress) it doesn’t change the reality that is what happened.  And as I’m a big proponent of dealing with reality instead of what you would like to had happen.  I’m inclined to argue that it (the faucet of capital) needs to tended with care.  The Fed should think more about system level capital (in addition to the bank level capital).  This is what should have been done (and quite possibly was done) with the stress test program. Also the Fed should avoid shocking the system by having it all paid back at once.  They may also want to consider unwinding their own interactions with the financial system before letting the traditional banking sector back away from the table.