Sunday, June 29, 2008

Smart equity, dumb debt?

I liked this writeup of a recent distressed real estate conference in Vegas.
Aside from say multi-family and really solid income producing properties (producing solid verifiable income now, not projected income) there is no debt available. There is lots of equity looking for 20% and up returns. Since these will have to be largely unleveraged, the asset price required to deliver the return is abysmally low. Further driving down implied valuations is the fact that the equity is Wall Street money with 3 to 5 year time horizons. No one thought that was achievable (with the exception of the Wall Street boys in the audience, of course).
Be sure to read a follow-up piece here. What interested me was the comment that these is lots of equity sitting on the sidelines, waiting for prices to be right before moving back in. I think this is exactly right. There is a huge amount of money looking for safe investment opportunities (as it runs from US treasuries to mortgage backed CDOs to commodities) and it is ready to step in when prices are right. The problem is that the right prices would reveal that the US banking system is insolvent, and arguably significant chunks of the US as well. The Fed and Treasury are in a difficult place as they try to lower prices enough so this money steps in, without actually revealing that the financial system as a whole, if it recognizes its losses, is at zero equity.

Friday, June 20, 2008


Like rats leaving a sinking ship, top execs are abandoning Yahoo! in droves. In the great debate over whether well compensated managers, loaded to the gills with stock options, actually add value or are simply lucky, the inability of Yahoo!'s execs, and President Susan Decker in particular, to generate organic growth or organize a sale, is an exhibit for the prosecution. (Exhibit B would be eBay, which has not created any shareholder value since 1999, although I'm sure Meg has drawn a salary in the past decade.)

Not that I believe a MSFT acquisition would have helped users, or MSFT at all, but surely Yahoo! shareholders deserve a break after having made no progress in 8 years? I expect that Jerry Yang will be asked to step aside, he's clearly the wrong leader for the company at this juncture, but I don't know who the "adult supervision" will end up being. As of 06-20-08 YHOO is trading at 23. Is now the time for a bold, contrarian play betting that MSFT will come back? Or, like LEH does the stock have 30% (and counting) downside left in it?

At this juncture in time it's fitting to consider Google, a company whose search product delights me more today than it did a decade ago when I abandoned altavista. The current CW is that Google is run by geniuses with a culture that is innovative, fluffy, and fantastic. When the tide goes out, we will see how true this is, for there are few second acts in the tech world. One of the most notable exceptions is AAPL of course, up a mighty 200x (that's 2000%!!) since 1985. The truest of true believers have been handsomely rewarded.

Thursday, June 12, 2008

Excellent graph

{Blogger sucks and once again, has broken its picture posting ability. Here's the link}

Source: Thomas Picketty and Emmanuel Saez, via WSJ

I love this graph. Next time folks talk about "taxing the rich", ask where "the rich" start. The top 10%-1% have seen almost flat income growth (1%-2%) over the past 6 years. So, up to $190K, no improvement.

From the top 1%-0.01% it's better, 7%-8.5% income growth. We're now at the $2.5M mark though. All the serious growth has been at the higher than 0.01% ($2.5M+) -- 22.2%!

Macro makes no sense

One area of economics that U Chicago shed no light on for me was macroeconomics, and monetary policy, which is ironic since it's the home of Milton Friedman who founded Monetarism. I don't think Megan understands it all that well either in this post
1. It would involve a massive, massive credit contraction. Hello, Great Depression.

2. Actually matching pool credit to particular loans would be a much more expensive business than the current banking system.

3. The expansion of credit has historically enabled a lot of things we like, such as homeownership and entrepreneurship.

4. How many people want to pay the bank to hold onto their money?

5. A smaller credit system will not ultimately prevent inflation/deflation. Without interest bearing accounts, savings become a wasting asset.

6. To the extent that it does prevent inflation, this is not necessarily a good thing--a little inflation greases the labor market, mitigating the effects of demand shocks.

1. It sure would. That said, the US$ has lost over 90% of its value in just three generations, and if that's a feature of the system, how great is that system?

2. Matching pool credit would be more expensive than maturity mismatched accounting as you would switch to, essentially, a multiple year cash accounting system. Other costs would be lower though -- no more FDIC. Other costs would be much lower, remember the US taxpayer is on the hook for almost $1T (yes, T) shoring up bad housing loans and the shadow banking system via recent Treasury and FNMA intervention.

3. Entrepreneurship would go on unimpeded. Remember, VC funding (a key driver of entrepreneurship) *is* maturity matched. Speculation would be less well supported though, and that is a feature, not a bug.

4. Suppose money did not lose value such that it became near worthless in three generations? Suppose you were hiring someone to protect gold? If we lived in a world of mild deflation (zero currency dilution + technological improvement) then paying a modest fee to have our cash stashed someplace safe would be fine.

5. You are correct that a smaller credit system will not, in and of itself, impact inflation/deflation. Monetary dilution (or concentration) is what drives inflation/deflation. Credit is part of this, and a bank's ability to extend credit (print money) via brittle maturity mismatched instruments is certainly dilutive. But there is also the government's dilutive ability to run the presses, and that element is quite independent of whether maturity mismatching is allowed or not.

6. The standard line is that some inflation makes it easier to cut wages, which has beneficial impacts on the labor market. I used to believe this also, and I still think it has some truth. I also think that, in an environment of mild deflation, over time people would make their peace with nominal wage cuts in the face of demand shocks.

Wednesday, June 11, 2008

The last financial crises of the 19th century

Brad DeLong has a reasonable capsule summary of the current financial crises, which he calls the last financial crises of the 19th century. It's true, this crises has its roots in Greenspan's excessive interest rate cuts after the .com bubble popped, but that happened in 2000, which would make it the twentieth century, no?

Two slides I'll point you to. The first is what Brad calls a "liquidity tsunami". As this blog has pointed out, "increasing liquidity" -- which means the government printing press increasing credit -- is by definition inflationary, and the inflationary forces the Fed has unleashed are quite extraordinary.
- $400B of treasury securities
- $500B via FNMA
- Guaranteeing the unsecured debt of every investment bank in the US
The goal of this money printing is to create a "leading sector", or bubble, to drive investment demand. I don't see anyone talking about what this leading sector should be, and if our last leading sector -- building houses no one wants in towns no one lives in -- lead us anywhere we wanted to be.

Tuesday, June 10, 2008

Financial regulation

Megan has an excellent post asking exactly what financial regulation should be enacted given the problems the US has had with the mortgage market, commodities mortgage, credit derivative market, prime broker market, etc. She correctly identifies the key issue
If you borrow short and lend long--and all banking is some variant on this--you will at least occasionally be caught out. There's no real evidence that the problem in the housing market was supply-side, rather than demand-side, fraud. Bear Stearns wasn't taken down by its SIVs. And it's not really clear that the originators would have behaved much differently had they been keeping a piece of the loans they packaged.
Agreed. She also goes on to say, correctly, that the Motherhood and Apple Pie recommendations would not have solved the problem
Here is, as far as I can tell, a comprehensive list of all the regulations that most economists could probably agree to:

1) Increased capital requirements for investment banks
2) Cracking down on fraud in the mortgage brokerage market
3) Less off-balance sheet activity
4) Requiring originators to keep a piece of the loans they package

The problem is, it's not really very likely that these four would have prevented the current crisis.
Given that the problem is maturity mismatching, the surely the answer is to simply outlaw maturity mismatching. Such banks have existed in the past, and there are similar financial structures today, such as VC funds. If real US productivity growth comes from actual real inventions and improvements, say from tech companies, and VC funding can supply us with that, is it worth having 3.5% saving accounts at the price of systematic instability and effective nationalization of the banking sector every 8 years?

The arguments raised over whether or not investment banks should be regulated are beyond the point. The moment investment banks became "too big to fail" was the moment became (informally) part of the Government, and as such, will be directed by the Government to the extent that any one government entity can direct another.

Small violins

Angry Bear has a "soak the rich" post arguing that it's OK to raise taxes on "the rich" since they've made off like bandits during the last 10 years, while salaries elsewhere have stagnated or fallen (if one ignores healthcare). His target is a $300K/year doctor, with $160K in debt from med school, saving for his kids education, and not looking forward to higher tax rates.

The thing is that $300K/year puts one in about the 3% income percentile, and that group has experienced wage stagnation just like everyone else over the past 10 years -- you need to get into the 1% income percentile to see actual dramatic income increases. Top 1% income in the US begins at $1M, and that top 1% pays 90% of taxes currently.

Friday, June 06, 2008

If your Momma says you're ugly...

Ed Glaeser, an academic at Harvard, is conflicted about Boston's City Hall. On the one hand, the building is hideously ugly and hated by the People. It also works poorly, and is hated by its Boston city government inhabitants. It is surrounded by a anti-human wasteland, rendering a huge swathe of prime downtown realestate uninhabitable, making it wasteful as well.

On the other hand academic architects like it. Glaeser himself says it "sears his soul", although I've found that it turns my stomach. Here's a picture of the poured concrete Vogon love poem, so you can make up your own mind. Please note that it's much worse in real life.

What does one do when the People disagree with the Academics? Glaeser lays out the plan
City Hall is a great building, and the building's advocates can convince the public of that fact. A democratic process will give architects the right incentives to make the public case for the building, and in making that case, they will help others to experience the masterwork's magic.
One must Educate the People! I thank the Boston Globe for this important public service announcement.

Tuesday, June 03, 2008

Almost there...

Bruce Webb lays out some clear, but little known, facts about Reactionary politics:
When we talk about a Reactionary today we generally mean nothing more than 'very Conservative'. But the term has a specific historical reference, it describes those who lined up behind the forces of Reaction in the years on either side of the nineteenth century. This Reaction was to specific events, notably the American and French Revolutions which were perceived, and rightly, as being systemic risks to the political, economic, and religious structure of society as it existed, not just to crowned monarchs (though Louis XVI showed that had to be taken into consideration), but to the aristocracy, the merchant and industrial class, and to the landowners. The key point to understand is that for the original Reactionaries 'Democracy' was quite literally a dirty word, it was considered and called 'Mob Rule'. Then further consider that the forces of Reaction did not at all believe that 'All Men are Created Equal' and rejected all three parts of the French slogan 'Liberte, Egalite, Fraternite', at least as they pertained to the working class in relation to them....

Which leads to the second point. In nineteenth century it was nearly impossible to draw any kind of clear lines between the drives for universal franchise, for the right to organize and bargain collectively, and for socialism. Indeed when the British Labour Party came into being at the end of the century it was organized specifically on all three lines.
All excellent points. I would add that today, even very conservative Conservatives are not Reactionary. I don't hear any calls to disenfranchise women, or to re-institute slavery. Infact, today's conservative Conservatives are the Progressives of the 1930s, and mere Conservatives are the Progressives of the 1950s. "Mainstream" is the Progressives of the 1960s. The trend is quite clear, as is the fact that Reaction, as a political position, has been utterly eradicated. So at this point, Bruce loses the plot a little:
Which leads to two questions. One was the classical economics stemming from Adam Smith shaped by the fact that its practitioners by and large lived in a society where exclusive privilege was a societal norm and where democracy was seen as an existential threat to that society? Two can the continued hostility to Social Security be explained as a simple continuation of a politics and an economics formed within a framework of Reaction?
His first point is a historical question, and although he thinks the answer is "yes" it is, in fact "no". Economics is called the dismal science because arch-Reactionary Thomas Carlyle, rightly, noted that it supported things like freedom of slaves, giving men the right to vote, and then ultimately, giving women the right to vote. He felt that all of these developments would be disasters. So "classical economics stemming from Adam Smith" was shaped by the fact that its practitioners by and large lived in a society where exclusive privilege was a society norm and where democracy was seen as an existential threat to that society and was working, along with other Progressive ideas, to bring about that very extinction. A task that was completed entirely successfully.

This fact answer's Bruce's second question, economists opposition to SS is not a continuation of Reaction politics as economists, really, are not at all Reactionary (although they may be conservative, or even Conservative). Also given the success of Reaction, conservatism, and Converatism over the past 200 years, SS in it's current, highly Progressive form, is not going anywhere.

Although economics today is scene as a force working on the side of conservatism, it began its life firmly on the side of Progressivism. The fact that Bruce sees classical economics as being Conservative tells us nothing about the origin of classical economics, and everything about how today's Progressives are much much more Progressive than yesterday's Progressive.

Gang up on Mankiw

Greg Mankiw got his spot in the Gray Lady's son by making an impish call to reduce the corporate income tax. He suggested paying for this tax cut by increasing the gasoline tax, thus striking a blow for environmental crusaders at the same time.

Steve Waldman takes issue with Greg saying that a gas tax is insufficiently progressive, and questions whether the US has the wisdom to deploy cheaper capital wisely.

I think that Steve should extend his compassion to polar bears, but am intrigued by his argument that when firms have more money but no new projects, they spend the money on stupid stuff instead of returning it to shareholders.
In theory, when firms do not have productivity-enhancing new projects at the ready, they return funds to investors. But, in the aftermath of first the dot-com bubble, and then a massive credit & housing bubble, it's worth asking what actually happens when the economy experiences positive shocks to the supply of capital.
Given that America invented the internet 10 years ago, it's shocking how much value it has also destroyed to find itself, 10 years older, with Google but no richer. It's even more shocking to consider that after this lost decade, the next 10 years look even worse.