Wednesday, May 30, 2012

Seriously, the World Would Like to Give Us Free Money

Remember when we wrote that the world wanted to give us free money, because the 10-year Treasury was trading at historic lows?

Well ... since then the yield on the Treasury has continued to go down.

Again, inflation is running at about 2.4%, and we can borrow at less than 1.7%. The rational response would be to borrow as much money as we can. Just sayin'.

Just for fun, here's the yield since 1960.

Friday, May 18, 2012

The World Would Like to Give Us Free Money

From the Wall Street Journal, sometime yesterday:

The rally in U.S. government bonds has put 10-year Treasury yields on the precipice of a new record low.
The benchmark note gained 18/32 in price by late-afternoon trading to yield 1.702% after sinking as far as 1.692%. The record low of 1.672% was matched in September and originally set in February 1946. Based on a 3 p.m. EDT finish, 1.702% would be the lowest yield ever to round out a session.
And from Yahoo Finance, at 6:22 this morning:

And here's a summary of current rates of inflation, from the Cleveland Fed:

With inflation running at about 2.4%, borrowing money at 1.7% means that -- in inflation-adjusted dollars -- there is no interest.

This would be an excellent time to spend a whole bunch of money on a new stimulus plan. Just sayin'. What with it being basically free and all.

Friday, May 11, 2012

What's Hedging, and How Did JPMorgan Lose $2 Billion by Doing It?

It's hedging, as in hedging a bet.

(Still yet another reminder that, at the end of the day, finance is mostly a fancy way of saying gambling.)

Some of the earliest (and most useful) hedges were in agriculture. A farmer would plant a crop in the spring, but wouldn't sell it until the fall. At that point, the price for his crop might be much higher (great news) or much lower (bad news) than he anticipated. The farmer, however, didn't want to speculate in commodities; he just wanted to sell his crop for a reasonable price.

Beginning in the 19th century, the future markets allowed him to do so. A farmer growing corn, for example, could sell all of his crop for $2.00 a bushel -- in April, when he was just putting seed in the ground. As he would not be harvesting his crop until, say October, this kind of transaction is called a forward transaction, as performance of the contract -- both paying the cash and delivering the corn -- don't  happen in the here and now. And because this kind of forward contract is standardized and traded on an exchange, this forward is actually a future. (So all futures are forwards, but not all forwards are futures.)

In October, though, the price might be $3.00 or it might be $1.00. But the farmer doesn't care, as he established a sale price of $2.00 in April. In financial terms, he hedged market risk (the chance that the price of his commodity would move against him) by selling futures on his crop. 

The idea of hedging moved into securities, where it spawned one of the more popular and profitable trading strategies -- the long/short strategy. The investor reviews companies within a given industry and tries to identify two things -- the most over-priced stock (e.g., the one least likely to increase in price), as well as the most under-priced stock (e.g., the one most likely to increase in price). 

Retail investors typically only look for the latter. People would buy Apple, for example, thinking that Apple would increase in value. But the long/short strategy is both a safer and, potentially, more profitable trade. So the hedge fund (as mutual funds can't really engage in short-selling, only hedge -- hey, there's that word again! -- funds engage in this kind of trading) would buy Apple (the long part), and borrow shares of Research in Motion (which makes the ill-fated Blackberries) to short-sell. 

The hedge fund ends up winning in these three scenarios:
  • AAPL goes up, and RIMM goes down.
  • AAPL goes up, and RIMM goes up -- but not enough to offset the gains made with AAPL.
  • AAPL goes down, but RIMM goes down even more.
The hedge fund loses in these two scenarios.
  • AAPL goes up, but RIMM really takes off.
  • AAPL goes down drastically, and RIMM only does down a little.
And the hedge fund gets creamed in one scenario:
  • AAPL goes down and RIMM goes up.
The problem with this trading strategy is that when the bets go south, they really go south. Fundamentally, this bet is on the spread between AAPL and RIMM. If the spread increases -- for whatever reason -- the bet is a winner. But if the spread moves against you, you get killed. This is what did in Long Term Capital Management, back in the '90s. 

With our agricultural example -- which is a true hedge -- the farmer was able to get rid of all of the market risk associated with his investment (his crop). Financial hedging just can't do that. A perfect hedge in the financial world would mean both buying and selling an identical amount of the identical securities, which makes no sense economically. So in the financial world, investors always look for imperfect hedges, meaning something which reduces risk, but doesn't eliminate it. Everything will be fine except -- again -- when both the original long investment and the hedge go against you. 

So what did JPMorgan do? According to Bloomberg
A JPMorgan Chase & Co. (JPM) trader of derivatives linked to the financial health of corporations has amassed positions so large that he’s driving price moves in the $10 trillion market, traders outside the firm said. 
The trader is London-based Bruno Iksil, according to five counterparts at hedge funds and rival banks who requested anonymity because they’re not authorized to discuss the transactions. 
The trader may have built a $100 billion position in contracts on Series 9 (IBOXUG09) of the Markit CDX North America Investment Grade Index, according to the people, who said they based their estimates on the trades and price movements they witnessed as well as their understanding of the size and structure of the markets. 
The positions, by the bank’s calculations, amount to tens of billions of dollars and were built with the knowledge of Iksil’s superiors, a person familiar with the firm’s view said. 

And it didn't turn out so well.
JPMorgan Chase, which emerged from the financial crisis as the nation’s biggest bank, disclosed on Thursday that it had lost more than $2 billion in trading, a surprising stumble that promises to escalate the debate over whether regulations need to rein in trading by banks. 
Jamie Dimon, the chief executive of JPMorgan, blamed “errors, sloppiness and bad judgment” for the loss, which stemmed from a hedging strategy that backfired
The trading in that hedge roiled markets a month ago, when rumors started circulating of a JPMorgan trader in London whose bets were so big that he was nicknamed “the London Whale” and “Voldemort,” after the Harry Potter villain. 
To be fair, this one incident doesn't really mean a lot to JPM, which made $19 billion last year. But it does support the argument for the Volcker rule, which limits how much money a bank can risk in the kind of proprietary trading JPMorgan engaged in. The bad news is that the Federal Reserve is delaying implementation of the Volcker  Rule for (at least) two more years, until 2014.

The other way to limit the amount of money in play, and the one which we strongly prefer, is to limit the amount of leverage banks can use. Banks hate this idea as much as, if not more than, Volcker Rule, because both are serious restraints on the banks' ability to make money.

This is true. But the federal government will always be called on to clean up financial crises, so it's more than fair for them to limit the amount of harm that banks can do to themselves. This, oddly, is how the federal government hedges its risk.

In Which We Take a Victory Lap with Citi's Economists

From an earlier post:

The idea of the helicopter drop – where the government would literally throw cash out of the side of a helicopter – originated with conservative economist Milton Freidman as a possible tactic to fight price deflation.
Ben Bernanke spoke positively about the effects of a helicopter drop in a 2002 speech at the National Economics Club.
So how would this work? Easy -- we just take one of Bush's plan -- the Economic Stimulus Act of 2008 and double it. 
But why do this? 
From an economic standpoint, the best thing would be if people were to take each and every dollar and buy something with it. A direct infusion of cash into the economy would have the greatest multiplier effect. But that's not going to happen -- but the alternatives aren't half-bad. 
If you're middle or lower class, you may take that money and use it to catch up on your mortgage. That’s not a bad thing, as it would help stabilize housing prices as well as increase cash flows to mortgage holders, which tend to be things like pension plans, mutual funds and financial institutions.  It would also reduce strain on Fannie and Freddie, as more and more of their mortgage-backed bonds were being paid off. (We own Fannie and Freddie, so we've got skin in this game.) 
If you’re up to date on your mortgage (or have none), you could take the cash to pay down a credit card payment. This won’t really help much in terms of stimulus, but it will, as Ben notes above, “improve the balance sheet of potential borrowers.” Meaning, if you’re thinking about buying a house or a car in the future, this should help you down the ways. And considering that the average interest rate applicable to credit cards is 15%, paying down a chunk of the principal now will significantly lower interest payments going forward -- meaning the credit card gets paid off sooner. It means the stimulus money will get spent, just not right now. 
Finally, if you're upper class, you're probably just going to save this money. That, bluntly, doesn't help the economy much at all -- see the multiplier chart above -- but not every plan is perfect. And the payout to the upper class would start diminishing if you made more than $75,000 single/$150,000 married couple. So the bulk of this stimulus will be going to people who aren't going to hold onto it.

And from CNBC on May 9th:

Citigroup on Wednesday issued a client note that just a few weeks ago would have read like satire. “We think central banks in the U.S., euro area, Japan, and the U.K. could and should do much more” to stimulate growth, said the firm’s economists, led by Willem Buiter. Yes, these institutions, which have already pushed their respective interest rates to historic lows and made unprecedented efforts to buy government bonds and other securities, are not being aggressive enough, the firm argues.
Specifically, Citi advocates a three-pronged approach: First, lower interest rates “all the way to zero” in the two regions, the U.K. and euro area, where they aren’t basically at zero already. Second, carry out “more imaginative forms” of quantitative easing  of any or all types of “less liquid and higher credit risk securities” beyond government bonds. And third, engage in “helicopter money drops,” by which they mean the fiscal authorities in each region should join forces with the central bank to pump money directly into their respective economies.

Wednesday, May 9, 2012

In Which We Take a Victory Lap in Regards to Our Stimulus Plan

But, ultimately, are swept up with melancholia.

From an earlier post:

Let’s start with compensatory aid for the states. State (and cities) typically have a much worse time during a recession than the federal government because they (a) can’t print their own money and (b) have to balance their budgets. So when revenues decrease, states have few options save for trimming their own expenditures. 
Calculated Risk, an economics blogs, says that we’ve lost 232,000 state and city jobs so far this year. And in California, things look like they’re going to get worse. From the Huffington Post
Because revenue is projected to fall short by more than $2 billion, the state could cut public school funding by up to $1.4 billion, though that amount will have to be determined by Brown's finance director. Besides laying off school staff, cutting expenses and dipping into reserves, the state could allow school districts to reduce the school year by up to seven days, from 175 to 168. California had 180 school days before the recession hit.

 California's unemployment rate – under 5 percent as recently as 2006 – has remained above 11 percent for more than two years.... It projects California's jobless rate will remain above 10 percent through the middle of 2014 and above 8 percent through 2017.
In short, direct aid to the states is a very efficient form of stimulus because it can prevent exactly the kinds of lay-offs and cut-backs that California is facing. Also, according to the Congressional Budget Office, they also have a relatively high multiplier effect – somewhere between 0.7 and 1.8.
Now, from the notorious pinko rag the Wall Street Journal:
One reason the unemployment rate may have remained persistently high: The sharp cuts in state and local government spending in the wake of the 2008 financial crisis, and the layoffs those cuts wrought. 
The unemployment rate would be far lower if it hadn’t been for those cuts: If there were as many people working in government as there were in December 2008, the unemployment rate in April would have been 7.1%, not 8.1%.
From TPM.

Friday, May 4, 2012

Um ....

From Zero Hedge:

It is just getting sad now. In April the number of people not in the labor force rose by a whopping 522,000 from 87,897,000 to 88,419,000.  This is the highest on record. The flip side, and the reason why the unemployment dropped to 8.1% is that the labor force participation rate just dipped to a new 30 year low of 64.3%.

If anybody thinks another stimulus package might be warranted, you can find our suggestion here.

Just sayin'.

Edward Conard is a Douche, Part Two

Remember this story from last year?

How's this for an example of just how porous the U.S. campaign finance system is? A recently created company made a $1 million donation to a pro-Mitt Romney political action committee, then went out of business, leaving no fingerprints from the money's donor. Michael Isikoff of NBC News reports on this fascinating example in an investigative piece. 
An excerpt: 
The company, W Spann LLC, was formed in March by a Boston lawyer who specializes in estate tax planning for "high net worth individuals," according to corporate records and the lawyer's bio on her firm's website. 
The corporate records provide no information about the owner of the firm, its address or its type of business.
Six weeks later, W Spann LLC made its million-dollar donation to Restore Our Future — a new so-called "super PAC" started by a group of former Romney political aides to boost the former Massachusetts governor's presidential bid. It listed its address as being in a midtown Manhattan office building that has no record of such a tenant.
Isikoff writes that the contribution is the fruit of the Supreme Court's Citizens United decision: 
Campaign finance experts say the use of an opaque company like W Spann to donate large sums of money into a political campaign shows how post-Watergate disclosure laws are now being increasingly circumvented. 
Much of this, the experts say, is because of last year's Supreme Court ruling in the Citizens United case that allowed corporations to spend unlimited amounts on political advocacy, including giving to supposedly "independent" super PACs like Restore Our Future. That ruling also opened the door for newly created nonprofit groups — such as Crossroads GPS, started by Karl Rove — that spent tens of millions of dollars on attack ads during last year's campaign without disclosing any donors. 
Well ...
The anonymous donor behind the headline-making $1 million contribution to a pro-Mitt Romney super PAC is a former Bain Capital official with long ties to the candidate, who's asking the outside group to amend its filings, POLITICO has learned. 
The check-writer is Ed Conard, who was a top official at Bain, the private-equity firm Romney helped create, and who has been a strong supporter of his over the years.

The donation, made to the super PAC "Restore Our Future" - which was founded by former Romney advisers and is able to take in unlimited contributions, but must report them to the FEC - showed up in the group's first round of filings. It was listed as coming from a W Spann LLC. 
In a statement to POLITICO, Conard said, "I am the individual who formed and funded W Spann LLC. I authorized W Spann LLC’s contribution to Restore Our Future PAC. 

Wednesday, May 2, 2012

Edward Conard is a Douche

The New York Times is running an article by Adam Davidson entitled The Purpose of Spectacular Wealth, According to a Spectacularly Wealthy Guy, which addresses arguments around inequality put forth by Edward Conard of Bain Capital.

Conard understands that many believe that the U.S. economy currently serves the rich at the expense of everyone else. He contends that this is largely because most Americans don’t know how the economy really works — that the superrich spend only a small portion of their wealth on personal comforts; most of their money is invested in productive businesses that make life better for everyone. “Most citizens are consumers, not investors,” he told me during one of our long, occasionally contentious conversations. “They don’t recognize the benefits to consumers that come from investment.” 
This is the usual defense of the 1 percent. Conard, however, has laid out a tightly argued case for just how much consumers actually benefit from the wealthy. 

Davidson then goes to completely avoid that tightly argued case, perhaps because it doesn't exist. Davidson does retell a story about how investment and innovation in computers has made them affordable to nearly everyone. And he even gets known pinko Dean Baker of the Center for Economic and Policy Research to acknowledge this is a true.

Baker estimates the ratio is 5 to 1, meaning that for every dollar an investor earns, the public receives the equivalent of $5 of value. 
Wow, that's pretty good!

So what's the problem? It has to do with what qualifies as an investment. Providing start-up capital to a new business, or additional capital to an already existing company, is an investment. Buying stock in the secondary market -- what most investors think of investing -- is not. It's gambling.

As we wrote here:

Unless you're involved in a public offering, all of the securities you've purchased have been in the secondary market. This means that not one dollar of the purchase price you paid went to the issuer. Instead, all of the purchase price went to someone who purchased those securities before you. You've made a bet that the security will rise in price and, if you're right, you'll win! But you won't owe taxes on gambling winnings -- which are taxed as regular income. Instead, these winnings are classified as capital gains, and taxed at a much lower rate.
Here is another example of how the tax code works to the betterment of the 1%. Capital gains (and their preferential tax treatment) are very much skewed towards the wealthy. In fact, in 2001, 2002, 2003 and 2007 (the last year for which data is available), more than 10% of all of the capital gains in the country went to just 400 tax payers.  
And those 400 returns represents those filed by the the top 0.00026%. Not the top 1%, but the top 0.026% of the top 1%. The remaining 90% of capital gains is filtered down to the 99.99974% of us.
Except that it doesn't. The top 0.1% ends up with nearly half of all capital gains, so that leaves 50% for the 99.9% of us.  
And all of that is taxed at 15%, the same tax rate which would kick in at $17,000 if you actually worked at a job. So if you made $8.50 an hour (and worked a forty hour week, fifty weeks a year), you'd be taxed at exactly the same rate which applies to the gambling winnings of the nation's wealthiest individuals.  
But it's actually worse than that, because we haven't figured in Social Security and Medicare taxes. As we noted in our discussion of Social Security,  capital gains are currently excluded from Social Security (usually 6.2%, but currently 4.2%) and Medicare (1.45%) taxation, So that's an additional 5.65%. 
This means that the lowest combined tax rate applicable to working stiffs -- 15.65% - will always be higher than the combined tax rate -- 15% -- applicable to the gambling winnings of the well-off. Always.
And it's not like Conard is an investor, at least in his professional capacity at Bain Capital. As we discussed here, private equity firms like Bain Capital are merely the leverage buy-out firms of the '80s with a makeover. Josh Kosman explained to Mike Konzal:
JK: The whole industry started in the mid-to-late 1970s. The original leveraged buyout firms saw that there were no laws against companies taking out loans to finance their own sales, like a mortgage. So when a private equity firms buys a company and puts 20 percent down, and the company puts down 80 percent, the company is responsible for repaying that. 
Now the tax angle is that the company can take the interest it pays on its loans off of taxes. That reduces the tax rate of companies after they are acquired in LBOs by about half. Banks, also realizing this tax effect, were willing to finance these deals. At the time, you could also depreciate the assets of the company you were buying — that’s not true today. 
They saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same. 
MK: So the business model is based on a capital structure and tax arbitrage? 
JK: Yes. It’s a transfer of wealth as well. It’s taking the wealth of the company and transferring it to the private equity firm, as long as it can pay down its debt.  
James Surowiecki of the New Yorker noted:
The rewards can be extraordinary: when Romney was at Bain, it supposedly earned eighty-eight per cent a year for its investors. But piles of debt also increase the risk that companies will go bust. 
[B]etween 2003 and 2007 private-equity funds took more than seventy billion dollars out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.

Tuesday, May 1, 2012

How to Make 30-40% More Right Now!

First, get a time machine. Then, travel back to the late '70s. Finally, prevent the benefits from increases in productivity from going mostly to capital instead of labor (to, in labor, to the top earners instead of the middle).

Paul Krugman explains.

Larry Mishel has a systematic breakdown of the reasons for worker income stagnation since 1973. He starts with the familiar divergence: productivity up 80 percent, the compensation (including benefits) of the median worker up only 11 percent. Where did the productivity go? 
The answer is, it’s two-thirds the inequality, stupid. One third of the difference is due to a technical issue involving price indexes. The rest, however, reflects a shift of income from labor to capital and, within that, a shift of labor income to the top and away from the middle. 
What this says is that widening inequality makes a huge difference. Income stagnation does not reflect overall economic stagnation; the incomes of typical workers would be 30 or 40 percent higher than they are if inequality hadn’t soared.