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Matthew C Klein

Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist. I have worked at the world’s largest hedge fund and read every FOMC transcript since May, 1987

Articles by Matthew C. Klein

Socialism with trolly characteristics

17 days ago

Imagine a world where you weren’t allowed to own anything.You could say you owned that watch, or that refrigerator, or that house, or those shares in that mutual fund, but you wouldn’t actually have a claim to any of it. Because in this world, the government would force you to regularly pay tax based on what you think your stuff is worth. If you can’t afford this carrying cost, too bad. You would have to sell. If you tried to low-ball your estimate of what you think your stuff is worth, you would be forced to sell to anyone with a higher estimate.How would regular people expect to live in a world where ownership is impractical for anyone without ultra-high incomes?The whizzes who came up with this plan — the same dynamic duo who believe index funds are a violation of antitrust — think all

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Marvin Goodfriend: the dovish counterweight to Yellen and Fischer?

18 days ago

Donald Trump may end up tilting the balance of the Federal Reserve’s Board of Governors toward looser policy if Marvin Goodfriend is appointed.This is not the mainstream view.Goodfriend cut his teeth at the Federal Reserve Bank of Richmond, which has a reputation of being more concerned with maintaining price stability than fighting against joblessness. He has repeatedly criticised the Fed’s bond-buying programmes, especially the purchases of mortgage-backed securities, which he believes (reasonably) are a form of fiscal policy. He is sympathetic to comparing Fed policy decisions to what would have been implied by a “Taylor-type reference rule”.Some analysts are already claiming he is “on the hawkish side of the street”. Others have noted his objections to the Fed’s slow and predictable

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One of Trump’s potential Fed picks is a huge fan of negative interest rates

22 days ago

From the New York Times:The Trump administration has selected candidates for at least two of the three open positions on the Federal Reserve’s Board of Governors, according to people with direct knowledge of the decision. The expected nominees include Randal K. Quarles, a Treasury Department official in the George W. Bush administration, and Marvin Goodfriend, a former Fed official who is now a professor of economics at Carnegie Mellon University.Goodfriend is described in the piece as a sceptic of the Fed’s bond-buying, especially its purchases of mortgage-backed securities because these ostensibly favour the housing sector over other areas of the economy. He is also someone who has expressed sympathy for binding the Fed’s policy decisions with simple rules.This might not sound like

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Have the Swiss National Bank’s currency interventions actually been good for Switzerland?

22 days ago

The Swiss franc has appreciated more than 50 per cent against its trading partners in the past decade:You might think this would have affected the Swiss economy, perhaps by hurting exporters and domestic companies that compete with imports from abroad. That in turn might have led to cuts in business investment, hiring, and consumer spending.You would, however, be wrong. The Swiss economy has shrugged off this apparent monetary tightening, and in some respects the currency appreciation has had the opposite of the predicted effect. Household consumption and business investment continued to grow at the same rates as before, while even the enormous trade surplus refused to shrink.The Swiss National Bank has felt differently. Since the start of the crisis, the SNB has tried to limit exchange

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Measuring financial conditions in poorer countries

29 days ago

Why care about finance?After all, economic output is just the number of people working multiplied by the average number of hours worked multiplied by average output per hour. If you want to raise living standards the trick is to increase output per hour enough that people can consume more stuff even as they work fewer hours. These are problems of social policy and technological investment, not capital markets and banks.But it’s the financial sector that tends to drive the booms and busts of the cycle. Changes in lending standards and asset prices affect decisions to save and spend, which in turn affect employment and production. It’s not a coincidence that American recessions are overwhelmingly driven by large drops in spending on motor vehicles and housing — big-ticket items bought on

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More on America’s unproductive homebuilding sector

May 25, 2017

American homebuilders started work on the same number of houses in the past year as they did a quarter-century ago, even though there are 36 per cent more people working as residential builders now than then. While this suggests stories about impending “labour shortages” are nonsense, it also suggests there was a severe decline in productivity that might partly explain the rise in US housing prices compared to places such as Japan.When we raised this last week, some astute commenters noted that the number of housing starts is an imperfect measure of residential construction activity, mainly because a large chunk of residential construction spending goes toward renovating or “improving” existing units rather than building news ones. Could improved measurement of output change the conclusion

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Japan shows America has no construction “worker shortage”, just a productivity problem

May 19, 2017

If you didn’t know any better, you’d probably think Japan builds far fewer houses than America, if for no other reason than the fact that Japan’s population is less than 40 per cent the size of America’s. You would, however, be wrong:Since 1992, America has built just 14 per cent more homes than Japan, despite the huge difference in population and the dramatic ageing of Japanese society. The chart below shows the ratio of the number of housing starts relative to the number of people in the prime home-buying age cohort of 25-54 in both countries:With the brief exception of America’s housing bubble, Japan has consistently built more than twice as many houses per potential homebuyer as the US.My colleague Robin Harding has elegantly explained that much of the robust demand for new housing can

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US stocks too expensive? Consider Japan

May 12, 2017

About 38 per cent of the enterprise value of the world’s listed companies — roughly $40.6 trillion out of $107 trillion, according to data from Aswath Damodaran — comes from firms based in the United States. It would therefore be unreasonable not to have a significant chunk of your portfolio invested in the world’s largest and most diversified economy.Unfortunately, American businesses are extremely expensive. The ratio of enterprise value to earnings before interest, tax, depreciation and amortisation for the companies in the Russell 3000 index has almost returned to its all-time high during the peak of the 1990s equity bubble:Unlike the ratio of price to earnings, the EV/EBITDA multiple is less prone to changes in accounting standards or capital structures. It simply captures the value

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Did you miss the epic rally in Greek government bonds?

May 9, 2017

Lots of things have happened since the start of 2016. The Chinese government shifted its macro policy stance from tightening to easing to (recently) tightening again. India embarked on a bold and painful experiment with “demonetisation”. The South Korean president was impeached for corruption. There were some elections in America and the UK.But is all that excitement an acceptable excuse for portfolio managers who failed to buy the Greek government’s 2042 bond back in February 2016 and missed the subsequent 59 per cent rally in price?(Thanks to Tradeweb for pointing this out and also providing the data.)While some of the rally tracks the broader recovery in risky assets after the Chinese government opened the credit spigots, almost half of those gains occurred in just the past few

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How should a “workers’ party” cut taxes?

May 4, 2017

America’s federal government currently collects about 19 per cent of national income in taxes:That’s high relative to the long-term average. It also seems high in the context of below-target inflation, real output far below trend, and a labour market yet to fully recover from the financial crisis. The time might therefore be propitious for a tax cut.The question is how to do it. The federal government collects tax in many ways. Workers and employers “contribute” to the national pension scheme (social security). People pay tax on income and capital gains. Heirs pay tax on inheritances. Companies pay tax on profits. Consumers pay tax on imports. At the state and local level there are also taxes on property owners and additional taxes on consumers, which hit the poor more than the rich.From a macro perspective, the distribution of taxes matters mostly because of how it affects spending and saving.If the problem were insufficient capital investment, it might make sense to facilitate the concentration of private wealth and lower the hurdle rate on new projects. That would imply cutting tax rates on high incomes while reducing taxes on dividends, interest, and capital gains. (This was one of the arguments made in the late 1970s and early 1980s for tax cuts back then.)This doesn’t seem to be the problem America faces today, however.

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Steve Rattner is peddling nonsense about America’s budget deficit

May 3, 2017

President Donald Trump wants to cut taxes. Reasonable people can disagree whether this is a good idea and can also disagree on the merits of the specific priorities reiterated last week.But reasonable people also need to support their arguments with actual substance rather than platitudinous scare-mongering — especially when their argument includes dire warnings against the long-term consequences for the budget deficit. A recent article by former “car czar” and disgraced private equity investor Steven Rattner fails the test.Rattner worries that “huge, unpaid-for tax reductions that saddle us with large amounts of new debt” will burden “our children and grandchildren”. Rattner’s main piece of evidence is the 1981 tax cut, which he claims “increased the budget deficit, helping elevate interest rates over 20 percent, which in turn contributed to the double-dip recession that ensued”.Literally none of that is true.The most salient economic event of the early 1980s was Paul Volcker’s decision — implicitly backed by the majority of the American people — to crush inflation by any means necessary. That meant imposing what West German Chancellor Helmut Schmidt called “the highest real interest rates since the birth of Christ” and inflicting the worst US downturn since the Great Depression.

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America’s rising consumer confidence mostly due to the elderly and less-educated

May 2, 2017

After more than a decade of disappointment, American consumers are now more hopeful than at any point since the housing bubble:Those who think surveys of expectations have predictive power for spending and saving might therefore conclude the uptick bodes well for America’s growth outlook. However, a closer look at who exactly is excited about the future suggests there is less here than meets the eye.Deutsche Bank’s Torsten Slok points out that the improvement in expectations is entirely due to Americans without a college degree, rather than those with greater spending power and higher earning potential. Americans with degrees have been getting steadily less optimistic since mid-2015:Americans without degrees are as optimistic now as they’ve ever been since the survey began nearly four decades ago. Only the peak of the tech bubble compares. By contrast, Americans with degrees are about as confident in the future as they were in September 2007, when the credit crisis had already begun:The shift since the election looks even starker if you look at the gap in expectations across the two groups over time. The change since November 2016 is unprecedented:Slightly less dramatic, but nevertheless revealing, is the change in expectations among younger people, who have their most productive years ahead of them, relative to older people, who do not.

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Blue-state Americans should worry less about the state and local deduction

April 27, 2017

Despite the lack of even the most basic details, feathers were ruffled when economic adviser Gary Cohn and Treasury Secretary Steve Mnuchin reiterated the tax policy priorities of the Trump administration on Wednesday. Particularly galling — to some — was the suggestion that taxes paid to states and local governments would no longer be deductible from federal income taxes. The concern seems to be that the change would raise the tax burdens of people who live in places such as New York City and California.The state and local deduction primarily benefits people with high incomes because those people tend to live in high-tax jurisdictions that vote for Democrats and because they pay enough in federal tax to justify claiming as many itemised deductions as possible. Some of these people may not think of themselves as “rich” even though they are at the upper end of the national income distribution.Some worry that wealthy people in these places may relocate, which might force additional tax hikes on those who remain, or cuts in spending. Of course, if rich Americans really were that sensitive to state and local tax regimes they would have abandoned their coastal enclaves long ago. Instead the migration pattern seems to be that the wealthy have been moving in while the poor and middle class move out, mainly because they can no longer afford housing.

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If you like the euro, why not just call for a global gold standard?

April 21, 2017

Before it was unfairly blamed for causing the Great Depression, genocide, and world war, the gold standard was considered not only respectable but moral, according to informed opinion. These days, informed analysts seem to agree with much of the substance of the classical gold standard, but they prefer to talk about it in starkly different ways. Perhaps we should take their arguments to their logical conclusions.Consider the euro.Members of the single currency are forced to issue obligations in a currency none of them can print. They made the choice to sacrifice their monetary sovereignty in exchange for lower costs of trade and greater cross-border financial flows. For the many members hoping to piggyback off Germany’s postwar record of stability, joining the euro would also mean eliminating the risk premiums associated with excessive inflation and devaluation. These were the same arguments that were made about the virtues of the gold standard in the 19th century.Ultimately, it was hoped, abandoning the peseta/lira/etc for the euro would promote integration with the wealthy northern core and convergence to higher living standards. (As it turns out, convergence was much more successful among the central and eastern European countries that didn’t join the euro.

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The BIS thinks capital controls are dumb

April 19, 2017

Hyun Song Shin of the Bank for International Settlements gave a thoughtful speech today at the International Monetary Fund’s spring meeting. There’s a lot in there, but the bit we want to highlight is his argument that the recent fad for “capital controls” is dumb.Large inflows of money from abroad can be deeply destructive, but they don’t have to be. What matters is the form those flows take:Yes, the 2008 financial crisis was in large part a cross-border phenomenon, but focusing on capital flows confuses the symptoms (capital flows) from the underlying causes (excess leverage and funding risk). If the problem is excessive bank leverage and funding risk, then address these risks directly with traditional microprudential, or regulatory tools. Applying these microprudential tools with macroprudential intent, or the intent to work on the whole financial system, is what makes them part of a macroprudential framework.Shin expanded on this by addressing a discussion we had with him and other luminaries at last year’s Camp Alphaville FT Festival of Finance, and our subsequent post on the case of Spain. We argued that if any country in the world would have benefited from capital controls, it would have been Spain. The implication is that if Spain didn’t need capital controls, no country ever would.

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High taxes didn’t give us democracy

April 19, 2017

April 18 was tax day in America this year. Normally a day of lamentation, the contrarians at Slate decided to celebrate the occasion by commissioning a tax law expert to argue that “modern Western democracy is nothing more than a byproduct of a series of tax disputes”.This is…not right.While we would never presume to explain the origins of representative government in a single blog post, we think it’s worth highlighting a few alternative theories.Start by considering why the “tax disputes” highlighted by Professor Chodorow emerged in the first place.In all three cases he mentions — the Magna Carta, America’s resistance to the Stamp Act and Townshend Acts, and the creation of the US Constitution — the government was trying to extract more from its people to pay for increasingly destructive wars. Greater influence on future decisions would be the compensation for paying up now.This didn’t always work. Anyone familiar with the history of the Magna Carta knows that King John had his deal revoked almost immediately — with the help of the Pope — and plunged England into civil war. The barons had to repeatedly win wars against the monarchy over the course of centuries to establish the supremacy of Parliament. Nowadays the Magna Carta is irrelevant to UK law as actually practiced.

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Smaller US banks better at banking than the big ones

April 13, 2017

The Federal Reserve Bank of New York recently released its latest chart pack covering “Quarterly Trends for Consolidated U.S. Banking Organizations”. There’s lots in there to digest, but one thing that stood out was the superiority of smaller banks — those with less than $50 billion assets — relative to larger lenders. The gap is particularly noticeable when compared to the biggest banks, defined as having at least $500 billion in assets.Start with net interest margins. The gap between what a bank earns on its assets and what it pays to fund those position is supposed to represent how much value it creates. Temporary big spreads could come from unsustainable risk-taking, but persistent net interest income suggests some combination of government subsidies and actual skill at finding borrowers to lend to. Now look at this:Smaller banks have net interest margins nearly double those at the biggest firms. This is even more remarkable since smaller banks are less likely to benefit from state guarantees than the “systemically important” institutions. Moreover, their margins have improved in the years since the crisis and resisted the downward trend many have blamed on monetary policy.Smaller banks weren’t taking more risks to achieve these superior returns.

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The Eurogroup is asking Greece to do something unprecedented

April 13, 2017

Historical experience—not just Greece’s experience, but that of a typical advanced country—is inconsistent with the primary surplus paths that would make Greece’s current debt sustainable.–“Does Greece Need More Official Debt Relief? If So, How Much?” by Jeromin Zettelmeyer, Eike Kreplin, and Ugo Panizza, April 2017The Greek government owes roughly €326 billion*.Thanks to concessional financing from the Greek Loan Facility, the European Financial Stability Facility, and the European Stability Mechanism, it currently pays an effective interest rate of just under 2 per cent. Were Greece to lock in this interest expense for a sustained period, its debt burden would gradually decline. All that would be needed would be for the economy’s nominal growth rate to stay above 2 per cent and for the budget excluding interest to remain in slight surplus.(Whether that would be enough to repair a society that’s suffered more than almost any other country in peacetime is a different question…)Things would be much more precarious if the Greek government couldn’t continue relying on concessional financing and had to borrow from the markets. The Italian government pays an effective interest cost of about 2.7 per cent and the Portuguese state pays 3.3 per cent.

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NY Fed research implies small business expectations are mostly worthless

April 11, 2017

One of the funny consequences of America’s presidential election was a massive spike in the “small business optimism index” published by the National Federation of Independent Businesses:The question is whether this will have any predictive power for business investment, hiring, sales, or credit demand. So far the data suggest the answer is “no”. Reasonable people might argue it’s too early to tell, however, and that the change in sentiment will eventually flow through to stronger growth.New research produced by the Federal Reserve Bank of New York in conjunction with the other regional Feds suggests otherwise. (Their survey of small businesses covered a range of subjects, focusing in particular on credit supply and demand.) The “expectations” of small businessmen just aren’t worth much because they tend to be unreasonably “optimistic”.The chart below shows that small businesses in the survey expect higher sales and that they’ll boost hiring:The difference between the share of small businesses expecting growth and the share expecting things will get worse has been consistently high for the past few years:Unfortunately these expectations had no predictive power.

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Traders appreciate United Airlines’s commitment to “cost efficiency targets”

April 10, 2017

I have great confidence we will achieve our cost efficiency targets outlined at our investor day as we look to offset rising fuel and labor costs.—Andrew Levy, executive vice president and chief financial officer of United Airlines, January 17, 2017Airlines are a notoriously tough business. In the United States, which refuses to subsidise national champions but also expects regular flights between unpopular destinations, carriers in the aggregate lost tens of billions of dollars since deregulation in the late 1970s.This shouldn’t be surprising. Airlines sell a commodity but have to buy landing rights and planes from monopolists. They rely on skilled labour, which can always be poached by flush state-owned competitors. And most passengers have repeatedy demonstrated they care more about price than anything else, which explains why the price of air transportation has grown far less since deregulation than either the broad consumer index or the index for services. No wonder almost every major US carrier has declared bankruptcy in the past 15 years, some more than once.Eventually, after years of consolidation, long-term investments in fuel efficiency, and brutal negotations with unions, the surviving big three (American, Delta, and United) found themselves in decent shape to exploit the cyclical recovery of the past few years.

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Post-crisis mortgages cost more but maybe that’s a good thing

April 7, 2017

It’s a quaint misconception that banks fund mortgages. They do, however, affect the price of mortgages by charging a spread over their cost of funding.New research from economists at the Federal Reserve Bank of Boston finds this spread has steadily increased since the crisis, with American borrowers effectively paying banks an extra $140 billion in 2009-2014 above what you might have expected given historical patterns. As they put it, “over extended intervals during our sample period, mortgage rates would have been 30–40 basis points lower under the counterfactual”.That sounds bad, but these extra costs may be there for good reason. Banks play an important role in American housing finance even though most of the credit is provided by others. Banks are supposed to vet potential borrowers, set appropriate terms for loans, collect payments, and foreclose in the event of default. (Unfortunately they also have a track record of foreclosing on people who didn’t default, and sometimes even on people who owned their homes outright…)Banks failed to do these jobs properly both before and during the crisis. Their underwriting was poor, which is one reason household debt ballooned, particularly among people who weren’t able to repay it. And when the bubble began to deflate, banks lacked the staff to ensure they followed the rule of law, modify mortgages, and do what was best for creditors.

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Sorry Jamie, Fed economists think bank capital is still too low

April 5, 2017

It is clear that the banks have too much capital.–Jamie Dimon’s latest letter to JPM shareholders, April 4, 2017In all cases the economic benefits of moderate increases in capital levels above current levels exceed the economic costs.–“An Empirical Economic Assessment of the Costs and Benefits of Bank Capital in the US”, Federal Reserve Board paper March 31, 2017Financial crises are bad.The present value of the damage from lower incomes, reduced investment, and higher joblessness is worth about a full year’s worth of output. On top of that are the psychic costs that come from losing employment and savings, which in turn may explain the linkage between crises and social strife that risks long-lasting damage to the institutions underpinning economic growth.Preventing crises — and limiting the damage they cause when they do occur — should therefore be one of policymakers’ top priorities. The most straightforward approach would be to eliminate private money creation. For those less inclined to radical change, the answer is raising equity capital ratios.After all, “financial crisis” is just a phrase that means “people dump risky assets so much that it hurts the real economy”. While indiscriminate selling can have many causes, having to repay lots of debt all at once — a bank run — tends to be the most powerful one. Equity is useful because it limits this danger.

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How America made Scandinavian social democracy possible

March 30, 2017

Change enough of the people in a society and you end up with different one.If everyone in Mexico (about 130 million people) moved to Texas (current population: about 28 million people) tomorrow, it would be reasonable to imagine that life in Texas would become somewhat more like life in Mexico is today.Migration waves of that scale and concentration are quite rare, of course. More common is for relatively small groups to move from one place to another, with the adventurous leavers generally quite different in temperament and ability than those who stay behind. Rather than transferring their native societies’ virtues and vices wholesale, these migrants bring with them a far more individualistic version of their culture than wherever they came from.Hence the not-unreasonable stereotype that places largely populated by voluntary migrants and their descendants — such as the United States — are more entrepreneurial, wealthier, and more unequal than source countries, such as Europe.New research presented at the annual conference of the Economic History Society suggests the stereotype fairly describes the outcome of migration from Norway and Sweden to the United States in the second half of the 19th century. (Thanks to Romesh Vaitilingam for pointing it out to us.

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What if breakeven inflation and the “term premium” are measuring the same thing?

March 23, 2017

There are two simple ways to think about long-term bonds yields:Traders’ best guesses about future short-term interest rates plus something extra — the “term premium” — to compensate for the risk that those guesses are wrongA long-term real interest rate plus something to compensate you for inflationSo here’s a surprising chart:The change in the Federal Reserve Bank of New York’s estimate of the “term premium” is, apparently, closely related to the change in the spread between US Treasury bonds and their inflation-indexed equivalents. For a given move in the five-year forward “term premium”, there is a corresponding move about half as big in the five-year forward breakeven inflation rate.The only serious exceptions are a few months in the second half of 2008 during the financial crisis and the summer of the “taper tantrum” in 2013. Take those out and the relationship gets even tighter, with an r-squared of 0.43.(Interestingly, the relationship looks much less tight if you use forward inflation swap rates instead of forward breakeven inflation rates. It looks about the same when using different time horizons for measuring changes.)There is no obvious reason why the claret and pink lines should move together so tightly. To understand why, consider what each thing is supposed to be measuring.Start with the claret line.

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In defence of Jim Cramer’s call to sell stocks in October 2008

March 15, 2017

[embedded content]In retrospect, this seems like terrible advice. Someone who had bought the Wilshire 5000 index of publicly-traded US stocks on October 6, 2008 would today be up about 180 per cent after reinvesting dividends.One man who seems to have listened to Cramer, to his apparent detriment, is Marty Bannon, father of Steve Bannon. From a recent Wall Street Journal profile, with our emphasis:With his children’s security a priority, Marty Bannon began accumulating phone-company stock, which AT&T occasionally made available to employees…he viewed the shares as an inheritance for his children, a lesson in the value of hard work and stability…Then came the 2008 market chaos…Marty Bannon says he lost more than $100,000 because he sold the shares for less than he paid for them.It was a decision he made without consulting a broker or his family, including his two sons with investment backgrounds, who only learned about the sale days after it was finished. The shares subsequently regained much of their value…That Oct. 6, financial analyst Jim Cramer told “Today” show viewers to pull money from the stock market if they needed any cash for the next five years. Steve Bannon says the warning spooked this father.The narrative almost nudges the reader into thinking Jim Cramer is partly culpable for America’s nativist turn.

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Trouble ahead for PE investors?

March 13, 2017

Buried in the latest issue of Bain & Company’s Global Private Equity Report are a few concerning nuggets for investors.First, buyout firms are paying extraordinarily high prices for their targets, even higher than during the last boom in 2007:Historically, the single best predictor of returns in private equity investing is the entry multiple. That shouldn’t be surprising since, in general, higher initial discount rates tend to produce higher returns across assets. Limited partners should therefore avoid using the performance of the recent past to justify their PE allocations, since future returns will likely be lower.As if that weren’t bad enough, Bain points out that the relatively strong performance of the past few years was itself caused by the same forces likely to depress future returns (our emphasis):For the subset of deals in Bain’s proprietary database invested after the global financial crisis, we compared deal model forecasts for revenue and EBITDA margin expansion with the results that each portfolio company actually achieved over the holding period. Most portfolio companies, we found, had relatively accurate projections of revenue growth. However, most did not attain the projected higher profit margins.This breakdown in execution had not come to light sooner because it was masked by macroeconomic factors, notably multiple expansion.

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More evidence in the case against Luxembourg

March 9, 2017

Luxembourg sometimes resembles a criminal enterprise with a country attached.The Grand Duchy’s appetite for other nations’ tax revenues ranges from its unusually low petrol taxes, which siphon commuters from neighbouring Belgium, France, and Germany, to its unusually generous treatment of multinational corporations.These predations are distasteful, but they are more or less legal, at least for now. Less justifiable is Luxembourg’s role as a centre for money-laundering and outright tax fraud.As Gabriel Zucman of the University of California-Berkeley has documented, there is a gap worth roughly $8 trillion (5 per cent) between the world’s financial assets and its financial liabilities. If that gap were randomly distributed across countries, it could be attributed to errors at national statistical agencies rather than anything sinister.However, the discrepancy is concentrated in a handful of small countries known independently as places favoured by tax cheats, including Luxembourg. The total value of foreign investments in Luxembourg, according to the local authorities, is worth trillions of euros more than what the rest of the world’s national statistical agencies claim their citizens own in Luxembourg. The most straightforward explanation is that many foreigners who own assets in Luxembourg are underreporting these holdings to their governments.

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Borio to central bankers: the “secular stagnation” is coming from inside the house

March 7, 2017

One of the most significant changes in the world economy in the past couple of decades has been the decline in real interest rates and the commensurate rise in indebtedness:The chart above comes from a recent speech by Claudio Borio of the Bank for International Settlements. The question is why it happened.According to Larry Summers and other exponents of the “secular stagnation” hypothesis, the downward slope of the red line reflects deep changes in the balance between the supply and demand for credit. If market interest rates — and central banks — hadn’t responded to these underlying fundamental changes, the rich world would have been plagued with decades of underemployment and slow growth in the decades before the crisis.The corollary is that rich countries must either depend on continuously falling interest rates and continuously rising indebtedness to sustain spending, or address the underlying causes of the supply-demand imbalance. Interest rates can only fall so far, however, which might explain the inability of many rich countries to return to what had previously been considered “normal” after the crisis.Borio recognises the unsustainability of continuously falling interest rates, but wonders whether the “secular stagnation” explanation makes sense.

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Will Nevada ever recover from the housing bust?

March 6, 2017

At this rate, probably not.Start with the state-level GDP figures, which show the real output of Nevada’s private sector is still more than 8 per cent below its previous peak:As hard as it is to believe, this understates the scale of the damage.Despite an undiversified economy stuck in the middle of the desert, Nevada continues to be one of the most popular places for Americans to move. It also has a relatively high birth rate.Adjusting for changes in population, Nevada’s real output is a staggering 21 per cent below its 2006 peak, and more than 10 per cent below its level from two decades ago — a performance only comparable to Greece:No wonder recent data from the Federal Reserve bank of New York shows that, unlike the rest of America, Nevadans are still cutting their debts ten years after the crisis:That’s even more remarkable considering the 70 per cent rebound in Las Vegas house prices since the trough in 2012. In the other states with the biggest booms and busts in housing — Arizona, California, and Florida — average household debt levels bottomed in mid-2013 and have since grown by as much as 10 per cent.Finally, consider Nevada’s employment. On the surface, things don’t look too bad. The unemployment rate has collapsed from 14 per cent to 5 per cent, while private employment has (finally) passed the pre-crisis peak.

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Fed vs Fed on strategic mortgage default during the financial crisis

March 3, 2017

Suppose you borrowed a lot of money to buy a house but now find it’s worth a lot less than you currently owe. If your lenders only have recourse to the house itself, you might have good reason to stop paying your debts and walk away — even if you’re perfectly capable of making continued payments.After all, your credit rating will take a hit but your net worth will improve significantly as you move from negative home equity to zero home equity. You might also save money by moving somewhere else with lower monthly payments. Since you never lost the ability to pay your debts, only the willingness to do so, your default would be “strategic”.A few years ago, economists from the Federal Reserve banks of Atlanta and Boston wrote an influential paper trying to quantify the importance of these “strategic” defaults. They found that 14 per cent of all the people who stopped paying their mortgages in 2007-9 had “both negative equity and enough liquid or illiquid assets to make 1 month’s mortgage payment”. In their view, this meant that strategic default was a “relatively rare” phenomenon and “not a major factor” compared to people defaulting because they were simply unable to pay.Their own data didn’t unequivocally support that conclusion, however.

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