Skip Piketty; Read Easterly

Here’s all you need to know about the most popular, least read, business book of the year. In his ponderous, repetitive, tedious, tortuous, tendentious, repetitive tome on the evils of inequality, Capital in the Twenty-First Century, Thomas Piketty, in the process of advocating for redistributive policies that—as I predicted two years ago—have failed spectacularly in his native France, unwittingly makes a great case for privatizing Social Security in the United States.

Piketty claims rising inequality is inevitable because investors’ return on capital exceeds the growth rate of GDP and workers’ incomes. If he is right, the best way to reduce inequality is to encourage workers to invest in stocks and bonds. Social Security prevents this by confiscating wages that workers could have saved and invested on their own account, creating middle class wealth that can be passed on to their kids. If you believe Piketty, reforming Social Security to permit this process of middle class fortune building is a no-brainer. In addition to reforming Social Security, Republicans should propose other reforms–such as creating 401K plans for all adults—that encourage workers to invest in stocks and bonds.

Easterly’s The Tyranny of Experts – a Brilliant, Iconoclastic Assault on Econo-Conventional Wisdom

William Easterly, an economics professor at NYU, is an expert on international development who takes a properly jaundiced view of his own profession. Years of seeing pompous, know-it-all development “planners” like Bill Gates and Jeffrey Sachs formulate costly schemes that fail to reduce poverty have given him a fresh perspective on the whole topic of economic growth, in both developed and developing nations. Here are a few insights:

  • The World Bank, IMF, Ford Foundation, etc. practice “authoritarian development.” Planners routinely ignore the rights of individuals in favor of the state. Easterly prefers “spontaneous cooperation” of individuals via markets, as opposed to “conscious design” by out-of-touch experts.
  • Top-down planning fails because planners simply do not have the necessary knowledge of on-the-ground local conditions, nor do they have an incentive to maximize the utility of the local population. For example, Thomas Jefferson thought the Erie Canal, the most successful infrastructure project in American history, was a really, really dumb idea; it had to be planned and financed by local politicians in the State of New York. One thinks immediately of Obamacare, where Ivy League professors and Congressional staffers force small businesses to use insurance policies the planners refuse to use for their own families. (Ivy League health insurance plans all brag about the “choice” and “flexibility” they offer participants; Jane and Joe Doe get no such choice.)
  • Planners place excessive emphasis on the performance of nations, when in fact patterns of development are regional—the countries in Latin America or sub-Saharan Africa tend to share similar problems.
  • Markets are “associations of problem solvers” using the price system to equilibrate the utility of consumers and the income of producers. Bureaucracies (think the Veterans Administration or the IRS) don’t answer to consumers; they answer to other bureaucrats and so have no incentive to maximize the utility of consumers.
  • One of the best ways to reduce poverty is immigration—whether from West Virginia to Ohio, or from Haiti to Florida. Plus, successful immigrants often send money back home to relatives, alleviating poverty in their home country. Liberal pundits (such as Alan Blinder in a recent WSJ column) routinely ignore how rising immigration necessarily increased “inequality” in the U.S. since 1980, even as it alleviated the poverty of immigrants and their relatives in the home country to whom remittances were sent. By the way, measured inequality in the U.S. is lower than it appears precisely because immigrants send money home, making the American residents appear poorer than they actually are.
  • Breakthrough technologies, such as the horse-drawn cart or the railroad, are often constructed from prior technological innovations. (In the case of the railroad, rails were originally used in mines, and steam engines were first used in factories and steamboats.)
  • Clueless development experts often operate with a “blank slate” – they have zero knowledge of the historical circumstances of particular countries. You might find an expert on Asia writing a detailed plan for how Brazil should be developed. We are now seeing the results of “blank slate” thinking in foreign policy; I doubt folks in the Bush Administration understood the significance of the Sunni / Shia schism before they invaded Iraq.
  • Here’s an insight from one of Easterly’s colleagues in the anti “development” fraternity, Dambisa Moyo: Development aid tends to undermine the political and economic power of a nation’s indigenous business community, because corrupt rulers can take a cut of the aid dollars while ignoring the needs of business community. Result: the rulers get rich but the economy remains under-developed. I suspect something similar has happened in the U.S. African-American community, where politicians and “community leaders” spending government money have more influence than black entrepreneurs and professionals.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Has Yellen Heard of Obamacare?

In this week’s Barron’s Randall W. Forsyth, citing research by Stephanie Pomboy’s Macro Mavens, makes a point I have been making for a few years. Supposedly strong employment gains in recent months, Pomboy notes, consist largely of part time jobs. Because of Obamacare, small companies are holding workers to less than 30 hours per week so that they do not count as “full-time employees” who must be given lavish benefits. In June full-time employment was still 3.4 million below its pre-crisis level. Mort Zuckerman made the same point in today’s WSJ.

The inevitable result of a shift to a part-time America is weak personal income growth. In May real personal disposable income grew only 1.9% year-on-year, and the 12-month moving average of this metric is a dismal 1.4%. How does that compare with years before the financial crisis, during the supposedly terrible reign of President George W. Bush? Between 2005 and 2007 the yr / yr percentage change of real personal disposable income averaged 2.6%, nearly twice as fast as the recent 12-month average. And don’t forget, Obama has delayed the employer mandate, so employers have not yet been socked with the full impact of the law. Furthermore, the cost of insurance will be rising rapidly for the next couple of years, which will inhibit hiring even more.

Fed Policy and Obamacare

Although many Wall Street economists continue to look the other way, the baneful effects of Obamacare on employment are pretty well recognized at this point. What people are still missing is the impact on Fed policy. When Janet Yellen looks at an economy with low labor force participation and just 1.4% average real personal disposable income growth, she sees an economy burdened by too much debt, which is allegedly restraining demand. She forgets about supply side constraints– regulations that are raising costs, hurting employment, and discouraging investment, such as:

  • Obama has sharply raised marginal tax rates on highly productive individuals.
  • Failure to reform America’s laughably dysfunctional tax code, which is impelling more and more companies to decamp to Europe.
  • Obamacare penalizes small business that go over the limit of fifty full-time workers. It pays to stay small.
  • The war on coal.
  • The Keystone XL Pipeline freeze.
  • The absurd ban on oil exports.
  • Onerous ozone regulations.
  • Dodd Frank curtails small business lending by wrapping community banks in unnecessary red tape.
  • Huge, capricious fines on major banks.

No wonder we have what Larry Summers mischaracterizes as “secular stagnation.”  By limiting supply and raising costs, these policies slow economic growth and make the economy more inflation-prone. Because she is misreading the causes of weak job growth, Chair Yellen’s easy monetary policy runs the risk of triggering inflation. I keep hearing that inflation can’t be a problem unless wages start to inflate. This makes no sense to me. Prices are a function of supply and demand; companies will raise prices if they can do so, regardless of what is happening to their own costs. A couple of weeks ago, I had a hard time finding a hotel room in Boston for less than $400—not because wages are rising in Boston, but because the hotel market is tight after five years of solid growth in the local economy.

I will be interested to see if Chair Yellen mentions regulation tomorrow in her Congressional testimony.

Krugman Flunks Finance 101

The good professor thinks he has figured out why conservatives oppose the Fed’s ultra-loose monetary policy, five years into economic expansion. Not only are they (unlike Krugman himself, of course) insufferably ideological and unscientific; they are also greedy. See, Fed policy has driven down interest rates, and it’s rich guys and gals—not the middle class retiree with a few hundred thousand dollars to invest—who get the largest share of their income from interest payments. Greedy rich conservatives hate Fed policy because their interest income is under pressure.

Krugman needs a refresher course in bond math. When interest rates decline, bond prices rise. These rich guys who supposedly have been hurt by Fed policy actually have garnered huge capital gains since 2007, while “working families” continue to be screwed by Obamanomics. For example, the iShares 10-20 year Treasury Bond ETF has appreciated from 96.96 on July 9 2007 to 129.37 now, a gain of 33.4%, in addition to which holders of this ETF have received 2%-5% per year in interest. That’s a total return, straight through a searing financial crisis, of about 7% per year. People in the top 0.1% who own lots of bonds have done much, much better than the average worker facing weak job growth and declining median household income since 2007. Krugman / Obama rhetoric favors the 99%; their policies favor the 1% and especially the 0.1%, even if they are not smart enough to know it.

Krugman seems to think super-easy money that risks inflation will help “working families,” but the opposite is true. The labor market is still weak enough that most workers do not have the bargaining power to get wage gains in excess of price increases, so their real incomes would decline if inflation picked up. The 1970s were a good decade for commodity speculators, but not for average workers.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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How to Play the Coming Bust in the Yellen Bond Bubble

It’s starting to get a little weird. Here we are, more than five years into an economic recovery, with an improving employment picture, strong stock market, OK housing market, strong auto demand . . . and the Fed is still easing via QE while keeping short rates at zero. That’s a monetary policy for a financial crisis, not the middle of a recovery. In her July 2 IMF speech, Chair Yellen admitted this is starting to cause excessive speculation, but she nevertheless intends to pursue an easy policy for a quite a while longer. That is music to speculators’ ears.

Two Remedies for Excessive Speculation

Yellen recognizes there are “pockets of increased risk-taking across the financial system” (such as shrinking spreads in the junk bond market). That will not, however, be addressed with higher interest rates, which could kill the patient as well as the disease. Instead Yellen will resort to “Macroprudential Policies” of two kinds—“building resilience” and “leaning against the wind.” “Building resilience” basically refers to the measures Dodd Frank and Basel III are taking to make banks and other institutions more resistant to panics – less leverage, more liquidity, less risk taking, a resolution regime if they get into trouble. Significantly, she had far less to say about “leaning against the wind” (one substantive paragraph versus four). Here she notes that Basle III and the bank stress tests pay due regard to “loss absorbing capacity.” She notes margin requirements could be boosted to rein in speculation.

Here’s the problem. The bond market is already overheated. Another full year of zero Fed Funds, followed by many months of minimal rates (0.25%-1%) will make the situation worse. Meanwhile excess capacity in the U.S. economy is shrinking and inflationary pressures are slowly building. Supply side blunders such as Obamacare, absence of corporate tax reform, the War on Coal, the XL Pipeline freeze, and wrapping community banks in Dodd-Frank red tape, are impeding productivity growth and making the economy more inflation-prone. When the bond market finally cracks, the rise in rates could be dramatic and wrenching, very likely causing a stock market sell-off.

The Tech Bubble

We have been here before, twice actually. We are in the third consecutive “jobless recovery” where the Fed was “looser for longer” than anyone expected, creating asset bubbles in the process – tech stocks in the 1990s, housing in the 2000s. It’s useful to consider what the Fed should have done differently to prevent these bubbles, and why it did not.

In December 1996, two years into the big stock market rally, Fed Chairman Greenspan made his “irrational exuberance” speech. Stocks stumbled but recovered fairly quickly. By 1997 Greenspan had bought into the “New Economy” hype; for example, a breathless Business Week article quotes a colleague saying ”He is very open to the possibility that we have entered a new economic age.” Greenspan was not wrong that improving productivity justified a looser for longer Fed policy in the late 1990s. (The Asian financial crisis also necessitated a rate cut in 1998.)   Where Greenspan erred was in confusing the economy and the stock market. Accelerating productivity did not justify an absurd and obvious mania in TMT (Tech, Media, Telecom) stocks. He should have ended the mania by:

  • first, giving another “irrational exuberance” speech where he explicitly threatened to raise margin requirements

and, later, when that did not work,

  • actually raising margin requirements dramatically, causing a stock market panic as leveraged speculators—day traders on Main Street as well as prop traders on Wall Street—dumped shares.

Clearly, this would have been politically difficult; a TMT crash would have cost influential voters huge losses. However, it would have been far better to have a brief panic in 1997 than a huge liquidation of absurdly over-valued stocks three years later.

The Housing Bubble

In 2005 or 2006 the Fed, OTS, OCC, FDIC and other regulators should have simply prohibited sub-prime mortgages and their close cousins, Alt-A mortgages. As described in my May 21 2014 post “Fed Freakout” (a fake 2006 WSJ article describing the likely fallout from such a ban) it would have caused financial and economic turmoil, not to mention a political backlash. But far better to burst the bubble early; the quality of sub-prime mortgages deteriorated dramatically in 2006 and 2007 as real estate prices became ever more inflated.

Yellen’s Bond Bubble

Yellen should take similar action now—something that surprises traders and prevents the worst junk bond issues from coming to market. A sell-off in crappy bonds and heightened market volatility would scare traders and keep them cautious. She would be castigated by the usual Keynesian suspects who see unlimited slack in the labor market, and also by central bankers in emerging markets enjoying low rates (such as India).

Unfortunately, there is no reason to believe Yellen will do it. On the contrary—and this is a key point—it appears that Yellen is relying on the aforementioned “building resistance” reforms such as Dodd Frank to prevent a bond sell-off from causing financial damage. But that’s a mistake. Financial speculation, like a hurricane’s flood tide, is hard to channel and contain. When the bond bubble bursts it will probably hit areas not now well regulated by the Fed and covered by Dodd Frank, such as ETF’s and bond mutual funds.

Macroprudential Policy Needs to be Unpopular to Work Well

Everyone likes a party, and no one likes the jerk next door who calls the cops when it gets too loud. To end a mania, regulators must take dramatic action that destroys fortunes, roils financial markets, and curtails economic growth. All of which elicit a political backlash that is difficult for regulators to counter because it is impossible to prove “what would have happened” if the mania had continued. Arguably, however, the searing experience of the 2008 crash makes it easier now than in the past for the Fed to step in and pop the bond bubble.

What Equity Investors Should Do

For now, keep riding the bull market higher. But don’t get too comfortable. At some point the combination of higher inflation, the end of QE, rising Fed Funds, lack of liquidity on Wall Street trading desks, and some unforeseeable event (a default, a war, a macro shock) will cause a severe bond market sell-off that scares investors and could slash stock prices 10-30%. It will be good to have some cash ahead of the panic.

As to timing, that’s tough to figure. Bull markets often last longer than you expect. Risks are rising but high valuation per se will probably not cause stocks to decline so long as interest rates are low and profits are rising. On the latter topic, bears are mistaken to argue that profit growth is merely driven by non-operational factors such as share buy-backs, restructuring, low interest rates, etc. As Q2 profits are reported over the next few weeks it will become apparent that profit and revenue growth are improving, in turn sustaining strong dividend growth in 2014 and very likely 2015. Using today’s price for the S&P 500 and estimated 2015 dividends, the index is yielding a juicy 2.4%. That’s still quite attractive in Janet Yellen’s zero Fed funds world.

Copyright Thomas Doerflinger 2014. All Rights Reserved.


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Greater Bond Market Volatility Ahead

I agree with comments that RBS’s Alberto Gallo made to Bloomberg in the past few days. Later this year we are likely to run into heightened bond market volatility, which may well hit stock prices for a while. We could see a battle between the bullish impact of a Republican victory and the bearish impact of rising bond yields.

Going into this year the consensus view, which seemed reasonable enough to me, was that bond yields would rise in 2014. This forecast was spectacularly wrong; long suffering bond bears are further discredited while bulls such as Pimco’s Bill Gross have become even more complacent. It reminds me of the stock market in 1999. Which could set us up for a surprising surge in bond yields (drop in price) later this year, due to:

  • QE ends – with the taper completed, the Fed will no longer be buying bonds.
  • Rising inflation as the economy continues to grow and labor markets tighten. Obviously labor is not an undifferentiated commodity like, say, soybeans. Even if many people still can’t find jobs, shortages are appearing in important segments such as engineering, nursing, trucking, oil & gas production, etc. By damaging the supply side of the economy, Obamanomics makes the U.S. more inflation prone, something almost no Wall Street economists are talking about. (See our June 21 post.)
  • Once bond yields start to drift upward, the fast money (hedge funds) will dump bonds. But market liquidity will be terrible because Dodd-Frank and the Volcker Rule are driving those dastardly investment banks to carry much lower bond inventories.  (By the way, in his book Street Test Tim Geithner basically admitted the Volcker Rule made no sense because it is impossible to differentiate between market making and proprietary trading. And prop trading had nothing to do with the financial crisis, which was all about making and packaging bad mortgage loans.) Recent weak profits in FICC are causing investment banks to downsize this business in favor of wealth management; often Wall Street firms make such moves at precisely the wrong time.
  • Here’s where it gets interesting. For a long time the dumb money has been “reaching for yield” by taking big risks it doesn’t understand in low quality fixed income instruments. That includes bond ETF’s and mutual funds, which own fairly illiquid long-term assets but offer instant liquidity to individual investors. This clearly worries regulators; last week the Financial Times reported regulators were considering slapping an exit fee on bond mutual funds to discourage mass withdrawals.  One of the iron laws of Wall Street is that financial innovations developed to meet ebullient investor demand during a bull market don’t work so well when prices drop and market liquidity dries up. That’s when we’ll find out whether ETF’s are as wonderful as their advocates claim. I have no problem with plain vanilla ETFs, such as SPY, sector SPIDERs, etc., but I would not be surprised to see some bond ETFs malfunction in a bond bear market, shocking investors who thought they were being conservative by avoiding stocks. Will busy-body regulators address this future risk now, or wait for a crisis? I am not optimistic.

I don’t think bond market volatility that drives up 10-year Treasury yields north of 3% will be a disaster for the economy or for stocks. However, equities could well take a hit for a few months as investors snap out of their “new neutral” “low bond yields forever” torpor and reassess the macro landscape.

Postscript: You Heard It Here 18 Months Ago—Endowments Post Poor Returns

A couple of days ago, the WSJ ran an article titled, “Big Investors Missed Stock Rally: Pension Funds, University Endowments Diversified Into Other Investments With Disappointing Performance.” This is consistent with my Dec. 22, 2012 post on “stock avoidance syndrome” where I agreed with Larry Fink’s then-contrarian bullish view of stocks. I noted Ivy League endowment funds had very low allocations to domestic equities and high allocations to “alternative investments” such as hedge funds, private equity, commodities, etc.  I wrote, “Individual investors are following the Ivy League money into these ‘alternative investments,’ but will they really deliver attractive returns as money pours in? We’re skeptical.” I have reiterated that view several times since then, most recently in April (Hedge Fund Madness—Providing a Way to Diversify Out of Sound Investments).

The lesson here is that financial markets are susceptible to sentiment swings lasting many years. Institutional investors fell out of love with equities and into love with hedge funds and private equity, which outperformed during the financial crisis but have lagged since 2009 while equities staged a huge rally. Because this surprised the morose media, pundits label it a “stealth rally.” Over the next few years, look for this syndrome to reverse. Investors will shift from hedge funds with high fees, mediocre performance, poor liquidity and limited transparency and back toward equities. Eventually, equities will again become excessively popular, as in 1907, 1929, 1972, and 1999.

Copyright Thomas Doerflinger 2014.  All Rights Reserved.

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Democrats’ Obama Problem: Part Deux

Back on May 8 I highlighted three New York Times articles lamenting Obama’s foreign policy incompetence, mostly with respect to Syria and Ukraine. All were designed to inoculate Hillary from Obama’s surpassing ineptitude. Alas, that post is already woefully out of date. A lot can go wrong in a month and a half when you are as clueless as Obama & Co. Lemme see, since then we have:

  • The Veterans’ Administration scandal. Obama, who as a Senator sat on the Veterans Administration Subcommittee and has been regularly promising to reduce VA waiting times for many years, claimed to be “shocked, shocked” at the bureaucratic mendacity and incompetence of the V.A..
  • Trading Bowe Bergdahl for five top terrorists–without informing Congress, as required by law.
  • Apparently no one in the Pentagon, CIA, NSA or State Department had a clue that Sunni “militants” would sweep out of Syria and grab a big piece of Iraq.
  • America’s southern “border” has evaporated as Central American children, making good on Obama’s “Dreamers” promise, pour into Texas and Arizona, accompanied by quite a few vicious gang members. They may be relocated to a Federal center near you. This dwarfs Jimmy Carter’s Mariel disaster, when Fidel Castro foisted 125,000 refugees, including many criminals and mental patients, on Florida.
  • The IRS’ absurd redux of the Nixon / Rosemarie Woods 18-minute audio tape gap. After two years of Congressional investigations the IRS casually reveals that, quite coincidentally, the e-mails of Lois Lerner and six accomplices for the relevant time period were lost with the simultaneous crashes of their six hard drives, which were (again quite coincidentally) promptly destroyed. Not even CNN is dumb enough to believe that, though the NYT probably is. You have to give Lerner points for originality. In all the previous investigations of corporations, banks, financiers, government officials, etc., this “hard drive ate my homework” excuse was never used. Unfortunately for Lois, these e-mails were received as well as sent, and exist somewhere in Federal cyberspace.

No wonder Obama’s approval rating is diving faster than a Peregrine Falcon targeting a pigeon. To save the Republic, let’s give him a free membership to St. Andrews and a one-way ticket to Scotland.

The only thing funnier than Obama’s surpassing incompetence is the liberal media’s efforts to change the subject. Supposedly it was a big disaster for Republicans that Eric Kantor lost his job to a dastardly “Tea Party candidate” (who actually received very little official support from the Tea Party). You would never know from the chatter on the Sunday shows that Republicans will gain seats in the House and Senate. What David Brat’s victory really shows is that conservative and many independent voters are fully mobilized because they’re “mad as hell, and we’re not going to take it any longer.” Get set for an earthquake in November.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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3-5% Inflation Will End this Rally . . . Eventually

Our bullish note of May 28 explained why stocks would manage to scale a new “Wall of Worry.” Since then stocks have climbed 2.4%; I think they are headed higher still. “Central bankers gone wild” are pumping liquidity into the global economy as if we were still in a deflationary spiral. In reality the global economy is growing and U.S. profits are rising nicely. We are in the proverbial “sweet spot.” Enjoy it while it lasts; inflation lie ahead.

Let’s start with profits. First quarter S&P 500 pro forma EPS were $28.00, which would seem to imply $118 for the year, because Q1 on average accounts for 23.7% of annual earnings. But Q1 results were hurt by bad weather and weak Wall Street profits, and the economy is recovering from its January-March deep freeze. Recent profit reports have been pretty good; see Kroger, Jabil, FedEx, Adobe. And rising oil prices boost profits, unless they cause a recession. Net net, profits should be better than $118, maybe $120-$121. That’s above most forecasts, which are in the $116-118 range.

While profits are better than feared, central bank easing and low bond yields support high PE ratios. At the end of last year, after stocks spiked, the trailing S&P 500 PE was 17x. Using that multiple for the end of this year implies a target of a 2050, up 5% from here. But that may prove conservative if investors celebrate a big Republican win in November. Historically, stocks are strong in the final quarter of mid-term election years.

An Inflation Scare Will End this Rally, but It’s Hard to say When

Last December we explained why “Yellenomics May Blow an Asset Bubble.” The paradigm, which was discussed on Larry Kudlow’s radio show a few months later, is simple. Obama’s systematic macroeconomic malpractice—Obamacare, higher marginal tax rates, the War on Coal, no Keystone XL pipeline, corporate tax non-reform, immigration non-reform, fulminations about “millionaires and billionaires”—are hurting job creation. However, to fight high joblessness Yellen is pumping liquidity into the economy. Because she can do nothing to reduce structural barriers to employment, the result is anemic job growth but rising asset prices. (Which is increasing inequality, but that’s another story.)

I see no evidence that Chair Yellen has figured this out. Despite the fact that we are five years into an economic expansion, with continued moderate GDP growth and increasing evidence of inflationary pressure, we have a zero Fed funds rate appropriate to a financial emergency, and the Fed is still easing monetary policy. “Tapering” of QE bond buying simply means the Fed is not tightening but merely easing less aggressively than a few months ago. But it is still easing.

Inflation Risks: Don’t Forget the Supply Side

Focused as she is on unemployment rather than inflation, Yellen will pursue a too-loose monetary policy as inflation starts to accelerate. That’s fairly obvious at this juncture. But here’s a key point that Wall Street economists tend to miss. Obama’s aforementioned macro-economic malpractice has increased inflation risks by hurting the supply side of the economy. He has shifted supply curves to the left; for any given price offered, less is supplied than in the past. Let us count the ways:

  • Higher minimum wages will constrain expansion of service industries and kill 500,000 entry-level jobs, according to the CBO.
  • The war on coal will raise electricity costs (coal still provides 40% of electric power).
  • Ozone regulation will raise the costs of manufactures, including gasoline costs.
  • As the CBO has documented, Obamacare subsidies will keep 2 million people out of the labor force.
  • Obamacare creates strong incentives for small businesses to stay small in order to keep “under the limit” of 50 workers.
  • Well over $1.5 trillion in corporate cash is kept outside of the U.S., much of which would be invested in the U.S. if it had a rational tax regime. The U.S. loses tax revenue and jobs as major companies decamp for low-tax venues such as Ireland and Switzerland.
  • Higher taxes on “millionaires and billionaires” discourage investment.

Excessively loose monetary policy and a sclerotic supply side will give us surprisingly high inflation, likely over 3%. Bond yields will climb, recession fears will rise, and PE ratios will fall. Historically, declining PE’s trump strong profits (see 1966, 1973, 1980, 1983-84, 1987, 1994). Stock prices may fall 10-20%, or perhaps just flatten out for a year or two while profits rise and PEs fall. In this environment “bond substitutes” such as tobacco, utility, and drug stocks will perform poorly, as will high-flying momentum stocks. “Inflation hedges” such as material, energy, gold, and mining equipment stocks should outperform. I would maintain a diversified portfolio and increase my cash position.

It will take a while for this inflationary scenario to develop, and it is hard to know when the inflection point will come. For now, equity investors will continue to enjoy the “sweet spot,” even if stocks become over-priced. Stocks usually trade above or below, not at, “fair value.” I’m glad I don’t have the job of calling the turn. To mangle an observation of Lord Keynes, “markets can stay irrational for longer than disciplined stock market strategists can stay employed.” In the late 1990s, many bearish—and ultimately correct–stock market strategists lost their jobs before stocks crashed. Cycles often last longer than you expect.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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In China Gray is the New Green

I usually wake up around 3:30 to catch the market action in Asia and Europe on Bloomberg and CNBC. It’s nice to get a non-U.S. perspective on all the craziness. Last night I was blown away by this exchange on Bloomberg between the anchor and a smart consultant who is an expert on consumer demand in China. This is a faithful representation but not an exact transcript. (This is not a parody; emphasis mine.)

Bloomberg Anchor: “So, what would you say is the current state of consumer demand in China?”

Consultant: “On the whole, it is the weakest I have seen in years.  The luxury market is weakening because of the anti-corruption campaign. Prada, Louis Vuitton, brands like that will have a much harder time. But tourism and foreign travel to places like Italy are holding up well, which is positive for luxury.”

Bloomberg Anchor: “What about auto demand?”

Consultant:Oh, demand for autos is very strong. The pollution is so bad in major cities that people don’t want to walk.”

Bloomberg Anchor:  “Oh my goodness.”

Consultant:  “Also, there is a rush to buy autos before the government limits the number of car licenses granted, as part of its anti-pollution drive.”

So this is what it has come to in Beijing, Shanghai and Quanzhou. People drive rather than walk to avoid pollution, but perhaps not for long because auto licenses may be limited by the government. I have not seen enough smart Wall Street research on how to play the anti-pollution drive in China. Clearly, companies involved in producing cars with lower emissions stand to benefit.

From Photosynthesis to Fossil Fuels

I have been reading essays by the great British economic historian E.A. Wrigley.  He makes the important point that the growth of traditional “undeveloped” economies was limited by the availability of land, because such acreage as was not devoted to producing food for man and beast was used to grow timber for construction and fuel. He calls this an “organic” economy limited by the power of photosynthesis to produce crops and trees.

This “organic” constraint, Wrigley argues, was finally broken by using fossil fuels. The Netherlands, the first European economy to grow rapidly, used peat (as well as windmills).  And then England began to use the enormous reserves of coal in the Northeastern counties, which was shipped down to London by coastal vessels.  Coal was dirty but effective in modernizing and industrializing England; it was used both for heating and for myriad industrial activities. Making bricks and glass, for example. After the Great London Fire of 1666 the metropolis was rebuilt in brick, yet the price of bricks remained quite stable during the building boom because brick makers using coal were able to vastly expand output. Thanks to cheap coal, most English farm houses had glass windows, which was not the case in France. Throughout the 19th century coal produced in a fairly small part of Britain was used to turn the country into “the First Industrial Nation,” boasting a higher living standard than continental Europe.

The pattern was different in the U.S., where early economic development was supported by abundant water power (which drove New England’s famous textile mills) and timber (which, converted into charcoal, sustained the iron industry until the 1840s). Steam engines were mainly used in steamships and railroads, not factories, in the first third of the 19th century.

Will Alternative Energy Take Us Back to 1600?

Why should we care? Because today’s “renewable energy” mania is once again making the availability of land a major constraint on energy production, as in the early 17th century. If you don’t get energy from coal mines, oil wells and gas wells, you need to cover the landscape with windmills and solar panels.  Ugh. Let me cite one example, which I highlighted in a November 2012 post titled “Suburban Sunstroke.”   Princeton University is proud to produce 5.8% of its electricity on 27 acres of bleak industrial wasteland (which I have surreptitiously visited) bearing the hilariously euphemistic label of a “solar farm.”  It is fenced off from wildlife; nothing grows there except forlorn weeds shaded by solar panels. Near the entrance are two or three sheds built with sheet metal and, in one corner, a giant heap of black asphalt. We saw a large white tail deer bound up a hill to the chain link fence surrounding the “farm;” it was forced to make a detour of several hundred yards. Very green!!!

Anyhow, let’s do some arithmetic. If the University uses 27 acres to produce 5.8% of its electricity, it would need a “solar farm” covering 466 acres to produce all of its electricity. If we assume, very conservatively, that the Town of Princeton uses as much electricity as the University, the two together would need to use – or should I say destroy? – 932 acres just to produce electricity for one tiny piece of New Jersey. That’s 11% more than the 843 acres in New York City’s Central Park. Oh, and by the way, the University gets subsidies from New Jersey tax payers to make its solar “farm” financially feasible—which means higher electricity bills for poor and middle class consumers to subsidize the green dreams of a university with an $18 billion endowment.  No wonder inequality is rising in Barack Obama’s America.

Copyright Thomas Doerflinger 2014. All Rights Reserved.

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Benign Deflation . . . or . . . Central Bankers Gone Wild

On Wall Street, alas, no bad deed goes unrewarded. After failing to anticipate even one of the past three recessions, and after sitting idly by during the housing bubble as the “safety and soundness” of the U.S. banking system evaporated, the Federal Reserve’s mandate expanded.  No longer does it merely set the short-term “policy rate” – the Fed Funds rate. Now it manipulates bond yields with “quantitative easing” and tries to precisely set the U.S. inflation rate. Alarm bells sound in the Marriner S. Eccles Building on Constitution Avenue when the inflation rate drifts below the Fed’s 2% target; supposedly this means we’re headed toward the same deflationary sinkhole that swallowed the U.S. in the 1930s and Japan in the 1990s.

In a recent speech Chair Yellen explained, “The FOMC strives to avoid inflation slipping too far below its 2 percent objective because, at very low inflation rates, adverse economic developments could more easily push the economy into deflation.”  Yellen thinks low inflation poses two risks. It raises the “real” Fed funds rate and, secondly, “persistent inflation well below this expected [2%] value increases the real burden of debt for households and firms, which may put a drag on economic activity.” Another central banker gone wild, IMF head Christine Lagarde, agrees, warning, “If inflation is the genie, then deflation is the ogre that must be fought decisively.”

Meet the Whacky Marx Brothers

The logical flaw in central bankers’ low inflation fixation is exposed by the famous Marx brothers, Manny, Moe, and Jack. They each agreed with Yellen and Lagarde while uttering these whacky non sequitors:

Manny, a graduate student in Boston: “High inflation is great. Paying off my student loans should be really easy, because for the past six years my tuition bills soared 10% per year. Unfortunately, salaries in my intended profession have been pretty stagnant.”

Moe, a middle class father: “This low inflation is killing me. It’s getting harder and harder to pay my mortgage because cheap natural gas is cutting my heating and cooling bills. Plus, I get all this free stuff on the Internet that I used to have to pay for.”

Jack, a small business man: “I love these inflationary pressures. Obamacare, a rising minimum wage, and Obama’s war on coal are sending my costs through the roof. I have to try to raise prices, but I’ll lose some customers and my profit margins will be squeezed. I’m holding off any new hires until my costs stabilize.”

The point is that often inflation (soaring tuitions that render higher education unaffordable, rising costs due to over-regulation) impedes economic growth and, conversely, deflation (cheaper energy, cheaper information via the Internet) unambiguously promotes economic growth.

Deflation / Inflation: the Cause Matters

Like many economists, Yellen and Lagarde’s Olympian 35,000 foot perspective ignores nitty gritty micro-economic reality—i.e., what causes high or low inflation.In the real world, there are two types of deflation, one “bad” and the other “good:”

  • Debt deflation, a vicious spiral where prices decline because consumers and businesses are unable to service their debts, so they sell assets, causing prices to decline further, which makes debt even more unmanageable.
  • Benign deflation, where technological advances cut costs, so consumers get more for less. Fracking and the Internet are both great examples.

Rather than lumping these two, diametrically opposite, deflations together and creating a simple-minded inflation target, central bankers and other policy makers should address the specific institutional problems that are creating debt deflation. That means “structural reform” to promote economic growth, thereby shrinking the debt/GDP ratio:

  • In the 1990s Japan failed to carry out structural reforms such as letting “zombie banks” die, eliminating incestuous cross holdings among corporations, deregulating farming and other protected industries, and opening up the country to imports.
  • In Europe today, many of these same reforms are needed. Europe is about five years behind the U.S. in recapitalizing its banks to promote lending to small businesses. Hollande’s tax hikes have hurt hiring. Little has been done to free up the Italian economy.
  • As for the U.S., Obama’s regulatory onslaught is raising energy costs and damaging what once was a flexible labor market. And there are the sins of omission—no corporate tax reform, no trade agreements, no Keystone XL Pipeline, etc. The result is slow growth and high unemployment. Debt, per se, is not the problem. Five years into an economic expansion the U.S. has already delevered; the debt burdens of businesses, governments, and households are manageable, provided economic growth is robust. Alas, I see no evidence that Chair Yellen realizes that over-regulation is impeding growth, particularly job growth.

Conventional Keynesians like Paul Krugman think higher inflation would benefit the middle class and hurt the rich. Wrong. Given a slack labor market and weak unions, rising inflation would not boost nominal wages much and real wages would fall, because rising U.S. inflation would weaken the dollar and increase commodity (i.e., food and energy) prices. This is the reverse of the 1998 pattern (see below). To the extent higher inflation reduced real interest rates, it would depress the incomes of middle class savers who own CD’s and bonds.  Meanwhile Wall Street speculators would adjust to higher inflation. Commodity speculation would come back into vogue, and highly leveraged, filthy rich, private equity tycoons would benefit enormously from a reduction in their real debt burden.

A Blast from the Past (1998): “Benign Deflation?”

We have been here before. In 1997 and 1998 deflation stalked the world economy as one “LDC” after another—Thailand, Indonesia, Korea, Brazil, Russia–succumbed to tightening credit conditions and declining investor confidence in their ability to service debt. Eventually, in October 1998, financial panic visited the U.S. as Long-term Capital Management, a giant hedge fund run by former Salomon Brothers “rocket scientists,” which had borrowed from all the big houses on the Street, imploded. As inventories piled up and commodity prices plummeted, economists feared deflation would drag down the global economy. Interestingly, Asia carried out the “structural reforms” that have eluded Europe and got back on its feet in a year or two. Weak commodity prices were one reason why real wage growth in the U.S. was strong in the late 1990s. Despite “deflation,” median real household incomes increased 8.4% between 1996 and 1999; by contrast, it declined 4.2% over the three years ending 2012.

As this unpleasantness unfolded, I co-authored a research report for PaineWebber titled “Benign Deflation?” which became a reading assignment for a course at NYU’s Stern School of Business. You can find it on the Web by googling “doerflinger benign deflation NYU.” Here are the “good parts.”

Excerpts from “Benign Deflation?”

  • If the U.S. were to experience deflation in coming years, it would be benign deflation similar to that of the late 19th century, driven by technological progress and accompanied by healthy economic growth.
  • Benign deflation is distinct from debt deflation, when prices plunge because debtors are unable to pay their debts, the financial system is damaged, and economic activity declines. The current turmoil in Asia is a prime example of debt deflation.
  • The risk of debt deflation in the U.S. is far lower now than in the 1980s, because 1) the U.S. economy has successfully made the transition to low inflation and 2) debt ratios are declining or stabilizing.
  • By preventing companies from boosting earnings through price increases, benign deflation encourages cost-cutting via innovation. This occurred in the late 19th century and is occurring today.

Deflation is compatible with Growth

Even though the price level was declining, the decades after the Civil War were a period of explosive economic growth and creativity. The completion of a continental railroad network, and the concomitant telegraph system, created a national market that encouraged a spate of technological innovations. The number of patents issued doubled between the 1860s and 1880s. Among the specific innovations introduced were:

  • Use of electricity in factories
  • The electric streetcar
  • Refrigerated cars for meat-packing
  • The telephone
  • The typewriter
  • The roller mill to process oatmeal and flour
  • Major advances in making steel, which replaced iron for many uses.

In the last four decades of the 19th century, value added by U.S. manufactures grew at a pace of 5-7% annually. From the 1870s to the 1890s—a period of rapid population growth driven by heavy immigration from Europe—national income per capita expanded by a remarkable 88%. It is quite possible that the deflation of the late 19th century to some degree caused this spate of technological innovation. Unable to raise prices in order to boost profits, businesses had no choice but to cut costs via innovation.

Increasingly, technological innovation will involve creative use of the Internet, which is doing for information what the railroads did for physical products—dramatically increasing the ease and speed with which information can be moved and manipulated. This is not only saving labor but also reducing inventory costs and raising the productivity of physical plant. By reducing inventory levels and minimizing inventory swings, better information technology is tending to mute the business cycle.

Copyright Thomas Doerflinger 2014. All Rights Reserved

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Stocks Can Scale a New Wall of Worry

Last year, despite slowing profit growth, U.S. equities experienced a “valuation levitation” because they were too cheap compared to bonds and cash. Why own a bond yielding 3-5% when you could own a stock with a 3% dividend yield, 8% EPS growth and 10% DPS growth? But late last year, after stocks had run up and many strategists boosted price targets, I flagged a worrisome “whiff of complacency.” The broad stock market did indeed take a breather in the first four months of 2014, but aggressive traders pushed “momentum stocks” to ridiculous valuations by the end of February, when the average PE on 2014 EPS of Tesla, FaceBook, LinkedIn and Twitter was 511x (or a mere 132x excluding Twitter).

Six Bricks of the New Wall of Worry

For stocks to make meaningful new highs from here, complacency and greed needed to be replaced by perplexity and fear. The proverbial “Wall of Worry,” which loomed large at the beginning of 2013, needs to be rebuilt. That is in fact happening as traders confront:

  • The painful collapse of many “momentum” stocks, partly due to forced liquidation by hedge funds.
  • This year small cap stocks (Russell 2000) have lagged the S&P 500 by nearly 600 bps.
  • Those two trends have led to what is, for many market technicians, a disturbing “divergence” between small caps and the S&P 500. Quite a few commentators on CNBC have argued that the S&P 500 will follow the Russell 2000 lower.
  • Supposedly stock market “fundamentals” have been disappointing. When stocks were soaring near the end of 2013, some investors talked themselves into believing this presaged a strengthening global economy. That view was mostly wrong; things have improved a little but not a lot. U.S. GDP was flat in Q1, much of Europe is stagnant, Japan is fairly weak, and China’s real estate bust is proceeding on schedule. Much needed “structural” reform in all these regions is mostly talk not action. Political turmoil in Ukraine, Thailand, Egypt, Libya, etc. does not help. Neither does the Obama Administration’s continued regulatory onslaught.
  • These allegedly deflationary macro pressures seem to be confirmed by the surprising strength of bond markets, with the 10-year Treasury yielding just 2.54%. The bond market is said to have a higher IQ than the stock market. Hmmm. That would be the same bond market that was priced for low inflation in 1972 (10-year Treasury at 6.21%) and hyper-inflation in 1981 (10-year at 13.92%).
  • Putting these macro factor together with A) uninspiring Q1 earnings and B) profit margins already at record highs, bears conclude that over the next few quarters weak revenue growth will produce major earnings disappointments.

But This Wall Looks Scalable

Those six bricks comprise the Wall of Worry that stocks need to scale over the next year, producing attractive relative returns. I think stocks can do it because:

  • It is bullish, not bearish, that dumb speculation in momentum stocks ended with a thud, before it got out of hand as in the 1990s.
  • Divergence between the S&P 500 and the Russell 2000? Even if you drink the technicians’ Kool-Aid, it all depends on your time frame. You could argue the divergence happened last year, when the Russell 2000 vastly outperformed SPX, and now the two indices are coming back into sync. Year to date the Russell has lagged the S&P 500 by 594 bps, but over the past two years both indices have appreciated 42-44%. Looks to me like convergence, not divergence.
  • The Fed is still dovish, as worried about deflation as inflation. Ultimately this could prove to be a mistake, but not yet. For now, loose monetary policy in Washington, Frankfurt, and Tokyo is keeping bond yields low.
  • The global macro picture may be worse than bulls expected, but nevertheless it is improving slightly, to about 3% global GDP growth this year from 2.5% last year. Europe, by far the most important foreign market for U.S. multinationals, is growing modestly rather than shrinking.
  • Despite bad weather which hit some industries hard, Q1 earnings were not too bad. Strategists continue to look for $117-$120 in S&P 500 earnings this year, and a 5-8% gain next year. The media do a poor job of assessing profits. They forget that U.S. nominal GDP is an imperfect proxy for revenue and EPS growth. Large companies can pull many levers to grow EPS, including organic revenue growth globally (not just domestically), acquisitions, restructuring / cost-cutting, and share buy-backs.
  • A big Republican victory in the November U.S. elections, which is looking more likely following the VA scandal and constructive primaries, would be bullish for stocks.

I admit stocks are no longer cheap. Using $118 in 2014 SPX EPS, the S&P 500 trades at a multiple of 16.2x, versus a 2004-2006 average PE on trailing pro forma EPS of 16.9x. But rates are much lower now. You have the choice of zero return on cash, modest return on overpriced bonds, or blue chip stocks that can deliver a high single digit total return comprised of 2% dividend yield and 5-8% EPS growth. And dividend growth will exceed earnings growth over the next two or three years. So stocks should be able to scale the new wall of worry. Some investors worry when stocks hit record highs, but don’t forget that earnings are also at record highs; this year S&P 500 EPS will be 109% higher than in 2000.

Copyright Thomas Doerflinger 2014.  All Rights Reserved.

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WSJ May 24 2006 Fed Freakout: a Bernanke Geithner Recession?

Fed Freak-out

A Bernanke Geithner Recession?

Real Estate Reels from Coast to Coast

By Randall Cunningham And Martha Ridzoli

WASHINGTON  May 23   The Federal Reserve’s surprise decision a week ago to prohibit sub-prime lending continued to roil financial markets and politics. Some analysts speculate it could cause a recession and cost Republicans control of Congress. Since the announcement stocks have dropped 8%, with the heaviest losses in financial firms exposed to housing such as Fannie Mae, Freddie Mac, Countrywide, and Washington Mutual, which have all dropped 16% or more. Shares of investment banks heavily exposed to sub-prime also declined sharply. In the bond market yields on lower-rated real estate related issues soared 150-200 basis points even as rates on 10-year Treasuries fell 35 basis points to 4.64%. Countrywide suspended a planned $350 million bond offering; its share price plunged 26% in two days. As part of its controversial decision the Fed pledged to provide liquidity to adversely affected firms; one fund manager likened that to the gun slinger who offers to pay his victim’s funeral expenses.

Economists disagree as to whether the Fed move will cause a full-fledged recession. Pessimists note that, after a prolonged spell of anemic job growth, hiring had finally accelerated, led by construction jobs and housing-related service jobs such as mortgage bankers, appraisers, lawyers, and realtors. The Fed decision is already having an impact. Wells Fargo announced 5,000 temporary mortgage servicing layoffs; Wachovia, Washington Mutual, and Countrywide made similar announcements. The housing market is starting to slow. Paul Johansen, manager of KB Homes’ new Alta Vista development near Sacramento, said traffic slowed sharply last weekend, with interest declining not only for entry-level homes but also more expensive models. “Move-up customers know the Fed decision makes it tougher to sell their homes to first-time buyers. We’ll finish the houses we’ve started but won’t be laying any new foundations for a while.”

Wall Street’s enormous mortgage banking machine is grinding to a halt, costing jobs and shrinking anticipated year-end bonuses. Last week trading desks took heavy losses on sub-prime paper, which may push some banks’ second quarter income statements into the red. Madelyn Wentworth, realtor with Douglas Elliman, expects sales of Manhattan co-ops and East Hampton vacation homes to decline sharply. “Buyers will pull back and wait for bargains to appear,” she said.

The Fed move met with harsh bi-partisan criticism on Capitol Hill, which has been bombarded with complaints from groups ranging from the National Association of Home Builders to the NAACP. “The Federal Reserve’s arbitrary decision will shut tens of thousands of hard-working middle class Americans out of the housing market. For them, the American dream will remain just a dream” said Martha Rodriguez, spokesperson for the NAHB. Barney Frank (D: Massachusetts), ranking Democrat on the House Financial Services Committee, said yesterday on Meet the Press, “Someone needs to remind Mr. Bernanke and Mr. Geithner that the mission of the Fed is to prevent recessions, not cause them.” Congressman Ron Paul (R: Texas) said, “The Federal Reserve’s reckless decision is a direct result of its promiscuous and unrestrained money printing which created a runaway bubble in the housing market. If anyone needed more evidence that the Fed is out of control and requires major reform, this is it.” Republican politicians attempted to distance themselves from the Fed decision but Nathan Gottesman, an independent political consultant, said “The probability the GOP can maintain control of Congress just got a lot smaller. Even if the economy merely slows sharply over the next six months and then recovers, in early November voters will be seeing economic reports from September, which won’t be pretty.”

Critics charged the Fed’s sub-prime crackdown was unnecessary, because it represents a small part of the mortgage market and an even smaller share of overall lending. They cite a 2005 study by Federal Reserve economists who “projected that even if there were a 20 percent nationwide decline in housing prices, it would cause only about half the economic damage of the bursting of the dot-com bubble.” One government economist stated, “Subprime is only about one-seventh of the mortgage market, barely $1 trillion out of the nation’s $55 trillion in financial assets, and it does not appear to be infecting the rest of the credit boom. Delinquencies on and loan losses on consumer lending continue to run at quite low rates.” But pessimists counter that the U.S. is in an unprecedented credit expansion fueled by rising home prices. They argue many low-income consumers are taking out risky, complex mortgages with low down payments that they will be unable to service unless home prices continue to increase. Even a modest decline in home . . . . .


TMD Note: The two quotations in the last paragraph describe actual Fed studies mentioned in Timothy Geithner’s book, Stress Test. Biased critics blame the financial crisis on bankers’ greed and deregulation, but that is only partly correct. Geithner does cite Alan Greenspan’s naïve faith in the rationality of markets; someone should have reminded Alan about the panics of 1819, 1837, 1857, 1873, 1893, 1907, 1929 and 1987. Both Greenspan and Larry Summers were far too confident in the ability of derivatives to limit risk; often they amplified it.  They should have known that financial innovations, not yet tested in a downturn, usually produce nasty surprises. (Think commercial banks in the 1790s, leveraged investment trusts in the 1920s, portfolio insurance in 1987.) Geithner takes pride in his cautionary speeches about financial risk delivered between 2003 and 2007, but no one on Wall Street was paying attention.

But regulatory failure was the product not only of free-market ideology but also malfunctioning government institutions. Deregulation? Many thousands of bureaucrats were showing up for work every day at the Federal Reserve, the Treasury, the Office of Thrift Supervision, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Office of Federal Housing Enterprise Oversight, and the New York State Insurance Commission, not to mention many other state agencies and various committees of Congress. Why was this cast of thousands so spectacularly ineffectual? As Geithner admits, “regulatory capture” (particularly at the Office of Thrift Supervision, Wamu’s regulator), fragmented responsibility (e.g., the Fed regulated Bank Holding Companies such as JPM and Citi but not their banking subsidiaries), and clueless incompetence (particularly at Chris Cox’s SEC, regulator of the investment banks) all played a role. No one had overall responsibility for survival of the system; everyone was handling just one part of the elephant. Senior folks at the Fed were insufficiently aware of crazy mortgage lending (which was being widely discussed on Wall Street), and they were too confident in their economists’ analyses. “Everyone knew” that some borrowers were taking out ridiculously risky mortgages, such as undocumented “liar loans,”“Pick a Payment” loans and low teaser rate mortgages, but no serious effort was made to prohibit them.

One key factor which Geithner ignores: Democrats’ relentless pressure on banks and Fannie/Freddie to expand lending to low-income borrowers. It started with the Community Reinvestment Act of 1977 and accelerated in the later years of the Clinton Administration, led by HUD Secretary Andrew Cuomo. Banks were under the gun to make what were later reclassified as “predatory loans.” Democrats, and some Republicans, opposed the Bush Administration’s efforts to pass legislation designed to reduce risk at Fannie and Freddie. So it is clear that a massive and multifaceted governmental failure was a prime cause of the financial crisis, which by 2005 or 2006 could not have been averted without a costly economic downturn.

Copyright Thomas Doerflinger 2014.  All Rights Reserved.


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