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Posted by Kevin Villani on 24th September 2016 (All posts by Kevin Villani)
When testifying in 2010 before the Financial Crisis Inquiry Commission into the financial crash, then Federal Reserve Board Chairman Ben Bernanke recommended only one reference, Lords of Finance: The Bankers Who Broke the World (2009), presumably for the narrative that insufficient money printing in the aftermath of the Great War lead to the next one. Right idea, wrong narrative!
The US homeownership rate peaked at a rate well above the current level almost a half century ago mostly funded by a system of private mutual savings banks and savings and loans. The historical justification for federal “secondary market” agencies was political expediency – exemption from now obsolete federal, state and local laws and regulations inhibiting a national banking and mortgage market. Now government-run enterprises account for about 90% of all mortgages, with the Fed their primary funding mechanism, what the Economist recently labeled a de facto nationalization.
The Historical Evolution
How did the private US housing finance system repeatedly go bankrupt? To quote Hemingway: Gradually, then suddenly. The two competing political narratives of the cause of financial market crises remain at the extremes – either a private market or public political failure – with diametrically opposite policy prescriptions. The politician-exonerating market failure narrative has not surprisingly dominated policy, with past compromises contributing to the systemic financial system failure, the global recession of 2008 and subsequent nationalization.
The Great Depression stressed the S&L system, but the industry’s vigorous opposition to both federal deposit insurance and the Fannie Mae secondary market proved prescient as the federally chartered savings and loan industry eventually succumbed by 1980 to the federal deposit insurer’s perverse politically imposed mandate of funding fixed rate mortgages with short term deposits and competition from the government sponsored enterprises.
The S&Ls were largely replaced by the commercial banks. To make banks competitive with Fannie and Freddie, politicians and regulators allowed virtually the same extreme leverage, in return for a comparable low-income lending mandate – CRA requirements leading to a market dominating $4 trillion in commitments to community groups to whom the Clinton Administration had granted virtual veto power over new branch and merger authority.
The Financial Crisis of 2008 and the aftermath
The Big Short by Michael Lewis and more recent movie portrayed not just banker greed but the extreme frustration of those shorting the US mortgage market stymied by a housing price bubble many times greater than any in recorded US history that refused to burst. The reasons: 1. the Fed kept rates low and money plentiful, and 2. whereas banks would have run out of funding capacity, the ability of Fannie and Freddie to continuously borrow at the Treasury’s cost of funds regardless of risk and their HUD Mission Regulator requirement to maintain a 50% market share kept the bubble inflating to systemic proportions.
The Obama Administration fully embraced the alternative private market failure narrative in Fed policy, regulation and legislation:
To partially ameliorate the effects on the real economy of disruption to the global payments mechanism the Fed had to bail out the banking system. QE1/2/3/4 and ZIRP (zero rates), now NIRP, did this by re-inflating the house price bubble, postponing defaults while allowing banks risk-free profits. The Fed – and taxpayers – would lose more than the entire S&L industry did should rates rise by a comparable amount if it marked its balance sheet to market.
Regulators had to appear to punish the banks. In response to paying hundreds of billions of dollars in what the Economist labeled “extortion” – some of which ironically went to populist political action groups – and the subsequent oppressive regulatory regime, U.S. commercial banks are exiting the US mortgage market in spite of ongoing profits enabled by extreme leverage.
One legislative centerpiece, the Dodd Frank Act passed in July 2010 in direct response to the financial crisis, doubled down on political control of financial markets without addressing the future of Fannie and Freddie. The other, Obamacare, enacted four months earlier, was similarly premised on regulating private health insurers to make health insurance simultaneously cheaper and more widely available.
The Long Term Consequences
Bernanke’s focus on choosing the narrative was useful, but the political choice of the market failure narrative appears to reflect convenience rather than conviction. The direct taxpayer costs of implicit or explicit public insurance and guarantees come with both a whimper – tax savings amounting to tens of billions annually due to the deductibility of interest costs – and a bang – future taxpayer bailouts generally delivered off-budget.
Fannie and Freddie conservatorship deftly avoided debt consolidation while dividends reduced reported federal deficits. The student loan market has also been de facto nationalized, with potential unbudgeted losses totaling hundreds of billions. Obamacare was similarly premised on regulating private health insurers to make health insurance simultaneously cheaper and more widely available, but under-budgeted health insurance subsidies predictable caused massive losses and health insurers are now withdrawing from the market.
Monetary policies caused household savings to stagnate as returns to retirement savings evaporated. Defined obligation public pension funds were all rendered technically insolvent when funding is valued at current market returns rather than the assumed rate as much as ten times that. The failure of the economy to grow per capita was explained as the “new normal”. But politicians made no attempt to reflect the implied technically insolvency of public pensions or Social Security and Medicare.
Private firms fail, but private markets rarely do. Public protection and regulation makes firms “too big to fail” until markets fail systemically. The current and projected future public debt bubble is unsustainable, and financial markets will eventually ignore the accounting deceptions and pop it. The relative weakness of other sovereign debt is delaying the inevitably, making The Really Big Short a good title for a Michael Lewis’s sequel. Politicians and central bankers will again say “nobody saw this coming”. What then?
==== Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath. This article was originally published at FFE.org
Investing has changed significantly during the 25 or so years that I have been following both the market and also the tools available for an investor to participate within the market. The following trends are key:
The cost of trading and investing has declined significantly. Trades used to cost more than $25 and now are essentially free in many cases. Mutual funds used to have “loads” of 5% or more standard when you made an investment, meaning that $100 invested only went to work for you as $95. These sorts of up-front costs have almost totally been eliminated
ETFs have (mostly) replaced mutual funds. ETFs “trade like stocks”, meaning that you can buy and sell anytime (mutual funds traded once a day, after being priced with that day’s activity) and they don’t have income tax gains and losses unless you actually make a trade (mutual funds often had gains due to changes in the portfolio that you had to pay taxes on even if you were just holding the fund)
CDs and Government Debt are all electronic. You used to have to go to a bank for various governmental bond products or to buy a CD. Now you not only can buy all of this online, you can choose from myriad banks instantly rather than settle for whatever your main bank (Chase, Wells Fargo, etc…) offers up to you
Interest Rates are Near Zero. One of the key concepts in investing is “compound interest”, where interest is re-invested and even small, continuous investments held for a long time can end up amounting to large sums (in nominal terms, because inflation often eats away at “real” returns). However, with interest rates basically near zero, you need to earn dividend income or take on more risk (i.e. “junk bonds”) in order to receive any sort of interest income. There is no “safe” way to earn income any more
Hillary is clever to go after individual companies. If she attacked the pharma industry as a whole, it could unite politically in response and perhaps gain political support from other industries that would reasonably see themselves as similarly vulnerable. But individual companies have no defenses against this kind of attack. By singling out one victim she discourages other industry players from doing anything in response, because any company or industry group that responds risks being targeted in the future.
She has done this kind of thing before. She will probably keep doing it because it’s politically effective. Her attack on Mylan destroyed a large amount of wealth, and probably not just for Mylan’s shareholders. Today Mylan’s CEO is groveling in the media. As with past political attacks by Hillary and others on vaccine manufacturers, yesterday’s attack on Mylan will discourage pharma companies from introducing valuable new products and will reduce the availability of current products. We will probably see more of this kind of extortionate behavior by the federal govt if she is elected, because that’s how the Clintons operate and because a Hillary administration would appoint more lefty judges and DOJ and regulatory officials who would go along with it.
At the store they offer plain, vanilla and chocolate soy milk. Chocolate is the only flavor that’s any good IMO. Other customers seem to agree as chocolate is always in short supply and sometimes sold out by the time I get to the store. It seems obvious they should stock more chocolate but they never do.
I complained a couple of times to guys in the dairy department and once to a manager. They didn’t understand what the problem was so I stopped complaining. When they have chocolate on the shelf I load up.
Today I took two cartons of chocolate and couldn’t reach a third. One of the stock guys climbed up on the shelf and got it for me. He good-naturedly said that it’s great stuff, it flies off the shelves. I thanked him and mildly suggested the store should stock more chocolate because it’s the most popular flavor. He said that, on the contrary, people who like chocolate should be more considerate and leave some for the other customers. He added that there is a God upstairs and He is watching. I believe this man missed his calling. He could have been a successful bioethicist.
If you want to slay the mistaken talk about the end of human employment, hold a contest. Come up with labor demand boosting ideas that we do not engage in today because we either don’t have enough people or don’t have enough money to do it. Weigh jobs that don’t require much intelligence or education as more valuable than those requiring high education/intelligence. Within a year I predict enough entries to be submitted to put the entire world to work multiple times over.
It is a bit embarrassing to think about things we are too poor to do. This makes these jobs invisible to us today. By creating a contest and an artificial market for these ideas, they become visible and we turn from despair at the jobless future to wondering how we can become efficient enough to afford to do all these wonderful things.
Let’s prototype the contest here, among friends (and a few special adversaries and maybe even some enemies), and maybe we can roll it out later on a larger scale. The winner will receive a microscopic amount of fame, and also a virtual certificate, not suitable for framing.
What are the things that we collectively and individually can’t afford–but might be able to afford given higher levels of productivity and national income–that would meaningfully affect well-being and human satisfaction? Define “things” as broadly as you like. Consider both things that could become more affordable due to productivity improvements in a specific industry, and things whose creation might not by itself be meaningfully improvable from a productivity standpoint but which people could better afford given an upward trend in overall productivity and income.
Every day, there are articles and blog posts about how quickly robots are replacing jobs, particularly in manufacturing. These often include assertions along the lines of “robots are replacing human labor so rapidly and so completely that it doesn’t really matter whether the factories are in the US or somewhere else.” There are also many assertions that robotics and artificial intelligence will triumph so completely that we must accept that we will permanently have a huge unemployed population who will need to be paid a “basic income” of some sort from the government.
This May, there were breathless headlines about how Foxconn, which is Apple’s primary contract manufacturer, was replacing 60,000 workers with robots–indeed, in some tellings, had already replaced them. If you google “foxconn 60000 workers”, you will get about 130,000 hits.
But the story, however, is false; indeed, it did not even originate with Foxconn but rather with some local Chinese government officials who wanted to promote their area as “innovative.”
There has also been a lot of coverage of robotics at Adidas, which is trying to use automation to improve the labor productivity of shoe-making to the point that it can be done economically in high-wage countries such as Germany. This article on Adidas also cites the Foxconn “60,000 jobs” assertion.
One key pair of numbers is missing from the stories I’ve seen on the Adidas project: the ratio of human workers to shoes produced, with and without the addition of the robotics. You can’t really judge the labor-reducing impact of the project without these numbers. In this Financial Times article, Adidas is quoted as saying, entirely reasonably, that they will need to get further into production with their new factory before developing meaningful productivity numbers. The article also cites Boston Consulting Group as estimating that by “2025 advanced robots will boost productivity by as much as 30 per cent in many industries.” Thirty percent is a very significant number, but it’s a long, long way from a productivity increase that would imply that factory jobs don’t matter, or that we’re going to inevitably have a very large permanently-unemployed population.
There are a lot of very significant innovations taking place in robotics and AI, but the hype level is getting a little out of hand. And it’s important to remember that automation is not a new phenomenon. For example, a CNC (computer numerically controlled) machine tool is a robot, albeit it might not look like the popular conception of one, and these machines, together with their predecessor NC (numerically controlled) machines, have been common in industry since the 1970s. One thing that articles and blog posts on the topic of robotics/AI/jobs could benefit from is a little historical perspective: do today’s innovations really represent a sharp break upwards in labor productivity, or are they more of a continuation of a long-term trend? And how, if it all, is the effect of these technologies appearing in the productivity statistics?
The drop in homeownership is largely due to a delay in homebuying by the millennials, who have the lowest ownership rate of their age group in history. Millennials are not only burdened by student loan debt, but they have also delayed life choices like marriage and parenthood, which are the primary drivers of homeownership.
Why have today’s young people, as compared to young people in the recent past, delayed buying property, marrying and having children?
“While the millennial homeownership rate continues to decline, it’s important to note that the decrease could be just as likely due to new renter household formation as it is their ability to buy homes,” wrote Ralph McLaughlin, chief economist at Trulia. “Certainly low inventory and affordability isn’t helping their efforts to own, but moving out of their parents’ basement and into a rental unit is also a good sign for the housing market.”
Why are many of today’s young families choosing to rent rather than buy their homes?
But let’s go even further. Even if you could prove that, on balance, free trade is an unquestionable economic benefit, people might still prefer to be measurably poorer if that’s the price that must be paid to maintain their traditional social and political cultures. (This has even more relevance in the case of the EU, because the EU actually has power. Imagine if NAFTA had an unelected Commission in Ottowa or Mexico City that could impose laws on the United States.) Perhaps people don’t regard their economic interests as important as their national or cultural interests. It doesn’t matter what elite opinion thinks the people’s most important interests are. In a democratic society, ultimately, it only matters what the people think they are. People get to determine their own priorities, and not have them dictated by elites. The people get to answer for themselves the question, “In what kind of country do I want to live?”
Of course, I would argue that we don’t have truly free trade or, increasingly, a free economy in the United States. The Progressives always look at the rising income inequality and maintain that it’s the inevitable result of capitalism. That’s hogwash, of course, and Proggies believe it because they’re dolts. But the problem in this country isn’t free trade—we have precious little of it—or unrestricted capitalism, since we have precious little of that as well. The issue behind rising income inequality isn’t capitalism, it’s cronyism. Income isn’t being redirected to the 1% because capitalism has failed, it’s happening because we abandoned capitalism in favor of the regulatory crony state and its de facto collusion between big business/banking interests and a government that directs capital to favored political clients, who become “too big to fail”. It doesn’t matter, for instance, whether the president is a Democrat or Republican, because we know the Treasury Secretary will be a former—and future—Goldman Sachs executive.
Franks’s post is very well thought through and ties together the main themes that appear to be driving US, British and European politics. It’s worth reading in full if you haven’t yet done so.
I’m surprised with all the sturm und drang of the brexit vote reaction in Scotland, it seems like everybody has missed entirely the easiest way for Scotland to rejoin the EU without a messy period of independence. It could apply for admission to the nation of Ireland based on their common historical roots.
The likelihood of this actually happening given the political stars of today is approximately zero. What I find interesting is the reason why the idea is so far out there that it wouldn’t even be brought up. If an independent Scotland has difficulty making a go of it, why is a Scotland tied to the English and out of the EU superior than a Scotland tied to the Irish and inside the EU?
The Orlando killer was not alone. He was a true believer and other believers in the mission of Islam inspire him. Neither he nor any of his predecessors or future companions are to be explained by psychology, economics, or sociology. They are to be explained by taking their word for what they are doing. If the President of the United States or the British Prime Minister, the media, the professors, the clerics, cannot or will not understand this reality, we cannot blame ISIS and its friends. They are also realists who understand where ideas and reality meet, sometimes on a battlefield in Iraq, sometimes in a night club in Orlando.
Shortly before the Brexit vote, writer Frederick Forsyth wrote about the basic character of the EU: Government by deception:
You have repeatedly been told this issue is all about economics. That is the conman’s traditional distraction. This issue is about our governmental system, parliamentary. Democracy versus non-elective bureaucracy utterly dedicated to the eventual Superstate.
Our democracy was not presented last week on a plate. It took centuries of struggle to create and from 1940 to 1945 terrible sacrifices to defend and preserve.
It was bequeathed to us by giants, it has been signed away by midgets.
Now we have a chance, one last, foolishly offered chance to tell those fat cats who so look down upon the rest of us: yes, there will be some costs – but we want it back.
A former ‘big proponent’ of the EU has this to say:
To be fair, the EU’s main problem has always been its troubled relationship with democracy…This contempt for the will of the people might still be perceived as tolerable if the leaders otherwise seemed sensible – but now that someone as bad as Merkel calls the shots in EU, we’re reminded of just why having perpetual democratic safeguards is so important…the EU’s contempt for European voters and its current attempts to shut down dissenting voices bodes ill for its ability to course-correct on its own. If the EU is to be saved, it first needs to be humbled, nay, outright humiliated in such a manner that no-one can doubt that recent developments can’t be allowed to continue.
My impression is that the best way to understand the next stage of the current market cycle is to recognize the difference between observed conditions and latent risks. This distinction will be most helpful before, not after, the S&P 500 drops hundreds of points in a handful of sessions. That essentially describes how a coordinated attempt by trend-followers to exit this steeply overvalued market could unfold, since value-conscious investors may have little interest in absorbing those shares at nearby prices, and in equilibrium, every seller requires a buyer.
Imagine the error of skating on thin ice and plunging through. While we might examine the hole in the ice in hindsight, and find some particular fracture that contributed to the collapse, this is much like looking for the particular pebble of sand that triggers an avalanche, or the specific vibration that triggers an earthquake. In each case, the collapse actually reflects the expression of sub-surface conditions that were already in place long before the collapse – the realization of previously latent risks.
One thing I have noticed over the years is when there is a crisis, it’s a really bad time to pass sweeping legislation. The momentum and justification for legislation comes from fear. “We don’t want that to happen again”, supporters say. For example, 9/11 happens and we get the Department of Homeland Security which is mostly a waste of money and allows the government to pry into all kinds of places it shouldn’t.
Dodd-Frank is a result of the financial crisis. There are so many bad actors in this crisis that it’s hard to list them all, but the root cause was the implicit backing government gave Fannie Mae and Freddie Mac-along with legislation and regulation that encouraged bad behavior. Sure, the ratings agencies were paid by the big banks and slanted the playing field. The big banks knew exactly what they were doing with the mortgages. But, without the implicit backing of government, the game never gets played.
Here are some data points:
Before Dodd-Frank 75% of banks offered free checking
After Dodd-Frank 25% of banks offered free checking
Small business costs are up 15% to comply with new regulation
15% less credit card accounts, and a 200 basis points more in cost
Remember, many small businesses get started by using credit cards. You might think they are stupid. But why should you import your financial/moral compass on them. Maybe they see the annual percentage rate credit card companies charge as cheap compared to the opportunity that lies ahead of them.
In the state of Missouri, there were 44 banks with less than $50M in assets. Prior to Dodd-Frank they were profitable. Post Dodd-Frank, 26/44 are losing money and will either go out of business or be consolidated. Your local community bank which is often the lifeblood of local capital is dead. How many other states are like Missouri? It’s no wonder small town rural America is having a tough go in the Obama epoch.
Dodd-Frank tried to make central party clearing mandatory for all transactions in the OTC market. Professor Craig Pirrong has blogged brilliantly about this and other aspects of Dodd-Frank. It works for a few, but not for all. This makes it more expensive to hedge risks. Businesses pass along the cost to consumers. In many cases, clearinghouses have to become the actual counterparty to the hedge. This stops commerce and more importantly has created more too big to fail institutions. Those too big to fail clearinghouses are now backed by the full faith and credit of the American taxpayer, you.
These are great points and Jeff’s post is worth reading in full.
Posted by Trent Telenko on 3rd June 2016 (All posts by Trent Telenko)
In my two previous blog posts here and here I talked of a new extended flow oil fracking technique coming on-line that resulted in a lot of drilled uncompleted wells (DUC) and the population of such wells (~5,000). In the comment section of one of those columns I speculated that we have a top end on oil prices where “turn on a dime fracking” will cut in at a price point of $50 a barrel
We now have a “flaming datum” for that speculation, oil having just bumped -HARD- into the $50 a barrel roof for world oil prices. The 5,000 DUC Frack-log is being activated with — I strongly suspect — the new extended play oil fracking technique.
It is being reported in various places that the US rig count jumped from NINE RIGS in mid-May to 325 last week and there was no change from 325 rigs this week. That is a 36 fold increase in rig count in a week!!
Based on figures I’ve gotten from those in the industry, the range of production you can expect from those wells, depending on the geology, length of the laterals (6,000 to 8,000 feet) and the number of fracking stages (200′, 300′ or 400′) will result in initial barrel per day production of between 400 and 800 barrels a day per fracked well (with a very, very rare 1,300 barrel a day play from time to time). So we are looking at between 130,000 to 260,000 barrels a day of American oil fracking production arriving in the next few months.
Compared to Saudi production, 130,000 to 260,000 barrels of oil a day represents between 1.3% and 2.5% of the Saudis’ daily oil flow. The number of DUCs activated to provide that production amount to 6.5% of the frack-log. And all that for what amounts to Zero “CAPEX” (capital expenditure), plus the operating expenses of worker wages, the rental price for existing, out of service, oil fracking rigs, and oil tanker trucks to move product to rail heads or oil pipelines.
Now you know why the Saudis didn’t agree with OPEC oil production cutbacks this week. The Saudis maxing out their oil production is no longer about stopping American oil frackers. The Saudis’ long term regime survival strategy amounts to being the “Last Petro-State Standing.”
The Saudis — like everyone else inside the Big Oil economic paradigm — simply cannot compete with that sort of rapid to market, low cost & low risk oil. The Saudis’ highest priority now is to keep their customers as long as they can, because if they lose them they may never get them back.
In his Foundation series of books, Isaac Asimov imagined a science, which he termed psycho-history, that combined elements of psychology, history, economics, and statistics to predict the behaviors of large population over time under a given set of socio-economic conditions. It’s an intriguing idea. And I have no doubt much, much more difficult to do than it sounds, and it doesn’t sound particularly easy to begin with.
Behavioral modeling is currently being used in many of the science and engineering disciplines. Finite element analysis (FEA), for example, is used to model electromagnetic effects, thermal effects and structural behaviors under varying conditions. The ‘elements’ in FEA are simply building blocks, maybe a tiny cube of aluminum, that are given properties like stiffness, coefficient of thermal expansion, thermal resistivity, electrical resistivity, flexural modulus, tensile strength, mass, etc. Then objects are constructed from these blocks and, under stimulus, they take on macro-scale behaviors as a function of their micro-scale properties. There are a couple of key ideas to keep in mind here, however. The first is that inanimate objects do not exercise free will. The second is that the equations used to derive effects are based on first principles, which is to say basic laws of physics, which are tested and well understood. A similar approach is used for computational fluid dynamics (CFD), which is used to model the atmosphere for weather prediction, the flow of water over a surface for dam design, or the flow of air over an aircraft model. The power of these models lies in the ability of the user to vary both the model and the input stimulus parameters and then observe the effects. That’s assuming you’ve built your model correctly. That’s the crux of it, isn’t it?
I was listening to a lecture on the work of a Swiss team of astrophysicists the other day called the Quantum Origins of Space and Time. They made an interesting prediction based on the modeling they’ve done of the structure of spacetime. In a result sure to disappoint science fiction fans everywhere, they predict that wormholes do not exist. The reason for the prediction is simply that when they allow them to exist at the quantum level, they cannot get a large scale universe to form over time. When they are disallowed, the same models create De Sitter universes like the one we have.
It occurred to me that it would be interesting to have the tools to run models with societies. Given the state of a society X, what is the economic effect of tax policy Y. More to the point, what is cumulative effect of birth rate A, distribution of education levels B, distribution of personal debt C, distribution of state tax rates D, federal debt D, total cost to small business types 1-100 in tax and regulations, etc. This would allow us to test the effects of our current structure of tax, regulation, education and other policies. Setting up the model would be a gargantuan task. You would need to dedicate the resources of an institute level organization with expertise across a wide range of disciplines. Were we to succeed in building even a basic functioning model, its usefulness would be beyond estimation to the larger society.
It’s axiomatic that anything powerful can and will be weaponized. It is also completely predictable that the politically powerful would see this as a tool for achieving their agenda. Simply imagine the software and data sets under the control of a partisan governing body. How might they bias the data to skew the output to a desired state? How might they bias the underlying code? Might an enemy state hack the system with the goal to have you adopt damaging policies, doing the work of social destruction at no expense or risk to them?
Is this achievable? I think yes. All or most of the building blocks exist: computational tools, data, statistical mathematics and economic models. We are in the state we were in with regard to computers in the 1960s, before microprocessors. All the building blocks existed as separate entities, but they had not been integrated in a single working unit at the chip level. What’s needed is the vision, funding and expertise to put it all together. This might be a good project for DARPA.
Another major reason the shale boom isn’t over is the large number of drilled but uncompleted wells waiting to be brought into production. There is an estimated 5,000 in the U.S. which can be quickly brought to market when the price of oil is high enough to reward it. Some companies have been completing them for some time, and more are being completed in 2016.
There are a lot of implications in that number. Starting with the fact that new oil & gas rig counts are going to be minimal for some time. And the hard economic fact that major politically event driven oil price spikes are going to be extremely short and will drop below 50 dollars a barrel within weeks to three months, given how fast these North American “DUC” wells can be fracked to bring product to market.
This new age of “banked” cheap oil plays, and the resultant oil price stability, will see off both the “Big Oil” economic model and the political/corporate elites that live by it.
Dr. Pippa Malmgren, founder of DRPM Group, former US Presidential Adviser and alumna of the London School of Economics, makes some very insightful connections between the breakdown of responsible economic policy in the USA and the increase of global warfare, from China and the South China Sea to Russia in the Ukraine.
She also explains that things like inflation don’t just happen like bad weather or something, they’re choices made by policy makers as a method of defaulting on debt.
If you people in emerging markets are experiencing knock-on effects from our (inflationary) policy, that’s your problem…It’s our dollar, and your problem! …They’re view is, I’m taking enough pain, you can’t expect me to ask my people to take even more pain by dealing with a global financial crisis and now demand has collapsed..you can’t ask me to inflict more pain. What is the end result? When central banks are trying to create inflation, a normal side effect is that hard asset prices go up…we’ve seen record all time prices for stock markets, for property, we actually seen record all time prices for things like proteins, which are particularly important in an emerging market context. Emerging market workers are spending 40%-70% of their income for food and energy, so price movements in this area matter.
Suddenly, all these pressures, all these problems are bearing down on these few smart people sitting in the West Wing who we think can solve this. And they’re speaking in a language that is highly technical, highly mathematical, it makes it very difficult for the general public to engage in the question. They’re told, Don’t worry about quantitative easing, it’s all in your interest! And they’re going, Yeah but my Cadbury Creme Egg, I’m getting less of those, and my rent is going up, and I can’t get a job still. But there’s a mismatch between the language the public wants to speak to engage in these issues and the language in which the policy discussion is conducted. And that a gap exists in understanding, What are the consequences of the choices that being made on our behalf?
A highly worthwhile use of an hour or so of your time.
(I posted this review four years ago…given the continued economic difficulties faced by many Americans, and the political implications thereof, this seems like an appropriate time for a rerun)
I’ve often seen this 1932 book footnoted in histories touching on Weimar Germany; not having previously read it I had been under the vague impression that it was some sort of political screed. Actually it is a novel, and a good one. The political implications are indeed significant, but they’re mostly implicit rather than explicit.
Johannes and Emma, known to one another as Sonny and Lammchen, are a young couple who marry when Lammchen unexpectedly becomes pregnant. Their world is not the world of Weimar’s avant-garde artists and writers, or of its risque-to-outright-degenerate cabaret scene. It is far from the world of a young middle-class intellectual like Sebastian Haffner, whose invaluable memoir I reviewed here. Theirs is the world of people at the absolute bottom of anything that could be considered as even lower-middle-class, struggling to hold on by their fingernails.
When we first meet our protagonists, Sonny is working as a bookkeeper–he was previously a reasonably-successful salesman of men’s clothing, working for the kindly Jewish merchant Mr. Bergmann, but a pointless quarrel with Bergmann’s wife, coupled with a job offer from the local grain merchant (Kleinholz) led to a career change. Sonny soon finds that as a condition of continued employment he is expected to marry Kleinholz’s ugly and unpleasant daughter, never an appealing proposition and one which his marriage to Lammchen clearly makes impossible. Lammchen is from a working-class family: her father is a strong union man and Social Democrat who sees himself as superior to lower-tier white-collar men like Sonny.
When Sonny and Lammchen set up housekeeping, their economic situation continually borders on desperate. Purchasing a stew pot, or indulging in the extravagance of a few bites of salmon for dinner, represents a major financial decision. An impulsive decision on Sonny’s part to please Lammchen by acquiring the dressing table she admires will have long-lasting consequences for their budget.
The great inflation of Weimar has come and gone; the psychological damage lingers. Sonny and Lammchen’s landlady cannot comprehend what happened to her savings:
Young people, before the war, we had a comfortable fifty thousand marks. And now that money’s all gone. How can it all be gone?…I sit here reckoning it up. I’ve written it all down. I sit here, reckoning. Here it says: a pound of butter, three thousand marks…can a pound of butter cost three thousand marks?…I now know that my money’s been stolen. Someone who rented here stole it…he falsified my housekeeping book so I wouldn’t notice. He turned three into three thousand without me realizing…how can fifty thousand have all gone?
Inflation is no longer the problem, unemployment is. There are millions of unemployed, and those who do hold jobs are desperately afraid of losing them and will do anything to keep them.
Posted by Trent Telenko on 15th May 2016 (All posts by Trent Telenko)
It isn’t often you see the death of a major worldwide industry. Last week I saw the death of the “Big Oil” economic model. It just died at the hands of Texas oil frackers who have developed a new “disruptive technology” that has made obsolete all the pillars of technology underpinning large, vertically integrated oil companies. More importantly, the same is true of all the petro-states that nationalized Big Oil’s assets in the 1960s to make all the state oil companies around the world today.
I found this out doing my day job last week as a Defense Department quality auditor visiting a mid-sized oil service company diversifying into federal contracts. The meeting was about issues with the contract they won and touched on others they have bid on. As a side bar at lunch the following points about their main business came up:
1. Oil field spending has died. Rig count in the USA is the lowest it has been since 1940.
2. One oil rig controller company these folks worked with saw a year over year drop of 72% in its business.
3. Another company they supplied had their “Cap-X” budget drop from ~$400 million for 2015-2016 to little over $30 million for 2016-2017.
4. One drilling company they supplied went from 120(+) new wells last year to _12_ this year.
5. This supplier sold a lot of copper tubing for “frack-log” drilling. That is the drilling of holes in good oil-bearing rock without fracking rock for oil immediately — and here is the new part — to take advantage of a new long-flow fracking technique.
While most of the points above are due to the Saudis’ oil price war on Texas frackers. An ex-Big Oil geologist I know put it this way —
The entire reason for the price drop was because the Saudis wanted to destroy fracking in the United States in order to keep us dependent upon them in order to keep them getting a free defense. The Saudis will have to diversify and start spending money on defense before the price goes back up, or they will be in serious trouble.
The technique in Point #5 above marks another “fracking revolution” that is of growing importance to the USA. This new fracking energy revolution will upend the world order as we know it. Political winds willing, America may well be a net hydrocarbon exporter in five to eight years.
Explaining why that is requires some background in Texas oil fracking.
Posted by Grurray on 29th April 2016 (All posts by Grurray)
Yesterday, the GDP figures were released for the first quarter of the year, and they showed that the economy is flatlining. We grew at only a pitiful 0.5%. Much of it was caused by a huge decline in business investment, which saw the biggest monthly drop since the recession.
This is mostly blamed on the troubles in the oil and gas industry, but output in other areas of the economy also showed weakness. Factory orders dropped and have remained flat the past several months. Car sales plummeted 2.1% last month, their biggest drop in a year. With gas prices low this is the one thing we should see rising. The car industry stumbling means there may be some other underlying problems.
The conventional wisdom, on the other hand, views this as just a blip. The winter season in the post-recession era has usually been the weakest time of year only to be followed by a rebound into the rest of the year. The exception was 2012 where the high hopes at the start gave way to the rising probability of an Obama reelection. The economic shock spread during the year, and the traditional holiday hangover came a little early in the wake of the electoral wreckage. This year, with the jobs market expected to stay strong and the Fed signaling it will put the brakes on further interest rate increases, the economy is seen bouncing back as the rough waters give way to the calm port.
It may very well turn out that way for all I know. My crystal ball has been a little foggy lately, so I wouldn’t venture a guess either way. However, there may be some other causes for concern further down the road. This week the McKinsey Institute just issued a research report on the stock market, ominously titled, Diminishing returns: Why investors may need to lower their expectations. In it they provide a detailed analysis of why the next 30 years will see lower stock market returns than the previous few decades.
Now admittedly, most analysts’ forecast for the next 30 days can usually be attributed to luck. A forecast for the next 30 years probably isn’t something you want to bet the whole farm on. A small corner of the barn maybe, but I would save the rest of the homestead to see how things actually unfold.
The report lays out in detail why the oversized returns between 1985 and 2015 were possible, and the reasons they say are because of four factors: low interest rates, low inflation, high productivity from technological advances, and favorable demographics from emerging markets entering the global economy. Nothing controversial there. The first three elements increased profit margins, and the last one provided cash influxes, which kept interest rates low, which in turn increased the others. Virtuous cycle – wash, rinse, repeat. They also include some calculations, but the self-evidence is apparent enough.
The wrench in the works is going to be the fact that those elements won’t have the effect that they once had. Interest rates are already rock bottom, and in some cases even below that. Squeezing more out of low yields is going to be tougher and tougher. In 1980 inflation was 13% and interest rates were 20%. Now they’re currently at 1.6% and 0.5% respectively. There’s nowhere to go but up. Sideways is always a possibility, but we’re still in the same boat. That won’t drive future growth either like it once did.
Demographic growth may still hold up. There’s still a whole lot of world out there with the potential to drive a modern global economy. The question is will they be capable of replicating what we saw in the recent past with hundreds of millions of Chinese rising out of the Maoist ashes and into the middle class? Any new emerging markets will have a lot more work to do. The report points out that the countries with the largest economies have seen slowing population growth, and that will continue to decelerate
In Western Europe, aging is more striking than in the United States. In France, for example, the share of the working-age population is expected to decline from 63 percent to 58 percent over the next 20 years. In Germany, the fertility rate has exceeded replacement rate in only seven of the past 50 years. Employment has already peaked in Germany, and its labor pool could shrink by up to one-third by 2064. Until the 2015 influx of refugees from Syria, Iraq, and elsewhere, the German population was expected to shrink by as much as 0.3 percent per year over the next 20 years.
Germany has decided to address their demographic collapse by welcoming in an unproductive culture. Either way they haven’t much left to contribute in preventing the forecasted shortfall.
McKinsey does hold out hope for some technological breakthroughs which could pick up the slack in productivity. Whatever it may be, they say it will need to have a bigger impact than the previous computer and internet revolutions because of the other headwinds. The best scenario would be in some combination with fast growing emerging market or industry. The problem with that happening is now that taxes and regulation are increasing, companies involved in fast growing sectors will tend to want to stay private, so equity returns will be elusive for only a select few.
Interestingly, one sector highlighted that will benefit from higher interest rates is insurance companies. The era of low to zero interest rates has made it difficult for them to make any money on annuities. Their annuities pay out guaranteed yields to customers, but ZIRP and NIRP keep profits low. Fixed income annuities in which insurers bear most of the risk will benefit from higher yields.
However, variable annuities where the customers share the risk have more exposure to equities, so they would be vulnerable to the lower growth/lower returns environment. Providers of variable annuities along with other asset managers will need to adjust their investment strategies:
To confront this, asset managers may have to rethink their investment offerings. One option would be for them to include more alternative assets such as infrastructure and hedge funds in the portfolios they manage. Such alternative assets already account for about 15 percent of assets under management globally today.
To chase returns, investors will be forced into riskier assets, possibly with dubious intentions, i.e. government boondoggles otherwise known as shovel ready infrastructure projects. We may already be seeing something like this with the imminent government takeover of financial advisors
The Department of Labor dealt a bit of a surprise blow to fixed indexed annuities in the final iteration of its rule, issued Wednesday, by lumping the annuities into a more complex and costly regulatory regime than they have presently, representing an about-face from the department’s original proposal.
Just like Obamacare pushes out the small to medium firms that can provide much needed innovation in order to capture the market, the new DOL fiduciary rules will push out small to medium sized advisors to replace them with automated puppets that will be programed to herd investors into investing in government programs.
There’s a good reason the Obama Administration is currently fighting so hard to keep these rules. It’s a template for taking over other industries. And with that it’s another impediment to productivity growth and innovation which reinforces the grim forecast of diminishing returns by McKinsey.
Often people focus on the “loud” items and miss the subtle, important events that really change the world. On the positive side, the 401(k) plan has that obscure name because a financial expert basically “invented” it out of a line in the tax code which enabled tax-deferred savings. And Jack Bogle of Vanguard did the same thing with “passive” investing, which reduced fees and for practical purposes has taken over the investing world (along with ETFs).
One very subtle item that is about to occur is the nationalization of state debt (and likely debts of individual cities) by the federal government. At the highest level, states and cities have made promises (mainly pensions) to their employees that are un-payable without raising taxes to extortionate rates. Detroit cracked first but since it was a city and there was some state framework they were able to use bankruptcy, but many more are to follow, including Puerto Rico (right now) and soon thereafter likely the City of Chicago or its teachers’ pensions as well as the state of Illinois.
A very similar event occurred in Europe when the ECB basically put the debts of Greece and Portugal onto the backs of taxpayers in Germany and Holland. The ECB had a moment (several moments, actually) when they could have fundamentally changed how Greece ran their economy, shutting down statist laws and heavy governmental interference in the economy to open up competition and growth, but they blinked and instead just “wired them money in exchange for promises”. The Greeks, of course, haven’t kept their promises, and why should they, given that the ECB continually blinks when the showdown occurs.
The reason that these states and territories like Puerto Rico are in dire straits is because they
1. Spend more money than they make every year,
2. Rely on borrowing to pay for operating expenses,
3. Have giant, unfunded liabilities on top of this that can never be repaid (pensions, medical bills, etc…).
This situation is enabled by a governing class that views funds as an opportunity to redistribute wealth to favored constituents and relies on “fairness” as a bedrock of their planning. The apex of this sort of planning can be seen in crony capitalist states like Brazil, where large enterprises like the National Oil Company (partially on the stock market, partially owned by the state) are used to fund politicians and social programs and are systematically diverted away from their core mission (to make money) until the enterprises are bled almost totally dry. Then, ironically, the state has to bail out the very companies that were supposed to provide for the socialistic wealth in the first place.
The CORE issue is – if you give these sorts of entities money (bailout) without a “root and branch” cleaning of the issues – you will just get more of the same, indefinitely, as their individually painful debts become part of the larger national (or pan-European) debt, which continues the little game of overspending and wasting money on favored political groups for a little longer (maybe a couple years, maybe longer).
The slippery slope – the trigger – is occurring right now in Puerto Rico. That entire economy is corrupt and ridden with subsidies from electricity to taxes to everything else. For Puerto Rico to thrive, it would need to break down barriers to private enterprise, reduce taxes, levies and bureaucracy, and find some way to bring logical industry into their jurisdiction. However, the more likely course is as follows:
1. Point out the current individuals suffering from a lack of funding (the poor, kids in school, the elderly),
2. Note that the debt which was once owned by individuals was bought up by hedge funds for a fraction of its original value – these funds are in a position to fight (legally and politically) for repayment and although they may be termed “vultures” or something else, they really are the last man standing for individuals who lack the means to fight legally for their rights,
3. Use the political system to “promise” reforms that will never be carried out (because why would you if you can use funds to enable the current system to thrive),
4. Talk about the retirees, and “promises” made to them over the years that cannot be paid, and how they can’t go back to the work force and earn more money so that they have to be made whole,
5. Use political or class warfare to point out the groups that run Washington don’t look like the groups that are broke and make it a fairness issue or tied to some century plus grievance.
It is very likely that these tactics will “work” and that the debts of Puerto Rico will be backstopped by the US government. While this technically isn’t a “bailout”, it absolutely is, because Puerto Rico can’t borrow one dollar on their own anymore (who would lend money to someone who says they won’t pay you back?), and we know that without major reform (which won’t happen) Puerto Rico will just continue to bleed money indefinitely (and fall back on fairness arguments and the above listed tactics to ensure that this keeps happening).
Then soon after this subtle bailout (and likely before Puerto Rico fails AGAIN, which will happen again as it will with Detroit), entities of Illinois or the state itself will drive straight through this loophole and federalize their debt, too. The state and entities will make lavish promises about change that will never occur, because this is the lifeblood of the Democratic Party (patronage workers and the public sector) and all of the clout / featherbedding / etc… will continue on indefinitely, without any of the sorts of laws that enable competition.
Watch the headlines… see this occur… it will be seismic in its long-term nature, because it will fundamentally change the nature of the US government, since the debts of the states and cities will become everyone’s debt and we don’t have any “real” tools to govern their behavior or fix the long-term promises that destroy competitiveness and economic growth.
This is the real story, it is happening under our noses, and instead of paying attention we are following these idiotic presidential campaigns of pure vapor.
(originally published in 2010 and now an April perennial)
Chevy Chase, MD, is an affluent suburb of Washington DC. Median household income is over $200K, and a significant percentage of households have incomes that are much, much higher. Stores located in Chevy Chase include Tiffany & Co, Ralph Lauren, Christian Dior, Versace, Jimmy Choo, Nieman Marcus, Saks Fifth Avenue, and Saks-Jandel.
PowerLine observed that during the 2008 election season, yards in Chevy Chase were thick with Obama signs–and wondered (in 2009) how these people were now feeling about the prospect of sharp tax increases for people in their income brackets.
The PowerLine guys are very astute, but I think they missed a key point on this one. There are substantial groups of people who stand to benefit financially from the policies of the Obama and company, and these benefits can greatly outweigh the costs of any additional taxes that these policies require them to pay. Many of the residents of Chevy Chase–a very high percentage of whom get their income directly or indirectly from government activities–fall into this category. Read the rest of this entry »
Barack Obama is fond of describing government this way.
As President Obama said the other day, those who start businesses succeed because of their individual initiative – their drive, hard work, and creativity. But there are critical actions we must take to support businesses and encourage new ones – that means we need the best infrastructure, a good education system, and affordable, domestic sources of clean energy. Those are investments we make not as individuals, but as Americans, and our nation benefits from them.
That was a reaction to Romney’s criticism of his silly comment.
The Department of Labor says its so-called fiduciary rule will make financial advisers act in the best interests of clients. What Labor doesn’t say is that the rule carries such enormous potential legal liability and demands such a high standard of care that many advisers will shun non-affluent accounts. Middle-income investors may be forced to look elsewhere for financial advice even as Team Obama is enabling a raft of new government-run competitors for retirement savings. This is no coincidence.
Labor’s new rule will start biting in January as the President is leaving office. Under the rule, financial firms advising workers moving money out of company 401(k) plans into Individual Retirement Accounts will have to follow the new higher standards. But Labor has already proposed waivers from the federal Erisa law so new state-run retirement plans don’t have the same regulatory burden as private employers do.
These are obviously depressed areas. Interesting, however, the number of comments along the lines of ‘Same here!’ I have no idea how representative this is, though I’ve read that things are very bad in Russia these days. Sanctions are currently biting in making things even worse. Remember to be grateful for where you live and what you’ve inherited.
Denial of consequences is an important part of left wing philosophy.
“California’s proposal would be the highest minimum wage we have seen in the United States, and because of California’s sheer size, it would cover the largest number of workers,” said Ken Jacobs, chairman of the UC Berkeley center. “This is a very big deal for low-wage workers in California, for their families and for their children.”
Implicit in all the assumptions is the belief that employers will not adjust by reducing the number of minimum wage employees they have.
The UC Berkeley estimate also includes some who earn slightly more than the lowest wage and stand to benefit from a ripple effect as businesses dole out raises to try to maintain a pay scale based on experience, Jacobs said.
If Brown’s plan passes, 5.6 million low-wage workers would earn $20 billion more in wages by 2023, according to the UC Berkeley analysis. It assumed no net jobs would be lost as businesses look to trim costs.
Even a former chairman of President Obama’s Council of Economic Advisers, Alan Krueger, has cautioned recently that “a $15-an-hour national minimum wage would put us in uncharted waters, and risk undesirable and unintended consequences.”
Posted by Kevin Villani on 19th March 2016 (All posts by Kevin Villani)
How Economists Facilitated the Transition of Erstwhile “Market” Economies to Fascism
The Left calls Donald Trump a fascist invoking the memory of Hitler and Mussolini, to which Trump might reply: “they were losers; I’m no loser.” Fascism is in essence the political control of the private economy, historically justified by democratically elected leaders to defend against perceived or orchestrated external threats. Progressive war politicians from Presidents Wilson and FDR to Johnson and Obama and now candidate Clinton have pursued this same goal in the US as has the social democratic European Union.
At the recent meeting of the G20 leaders and central bankers political responsibility for and control over their respective economies was assumed, but their Alfred E. Newman “what, me worry” smiling faces belie the fragility of the current global economy. The political distortions to both the financial and real economy have arguably never been greater, to which politicians and their economist enablers prescribe more of the same mostly wasteful public spending financed by money printing, a cure reminiscent of medieval bloodletting.
Having never been of much use to business, economists mostly followed “Say’s Law” that supply creates its own demand (for academic economists). They got their first pervasive shot at political power when President Wilson – an academic who chafed at constitutional constraints – created the Federal Reserve which helped US bankers fund the Allies until he could mobilize a war economy, making the first WW “Great.” The unprecedented death and destruction of the Great War knocked the global economy off kilter and the massive international war debts made stabilization politically difficult. As the creditor and least damaged victor, the US economy boomed in the roaring ’20s, followed by a bust.
Purveyors of the “dismal science” had previously counseled that politicians had to own up to the cost of war until the private economy recovered. While the “arts” of manipulating the value of currency and public spending financed by coercive taxes and often uncollectable debt as well as coercive regulation were as old as politics and war itself, post WW I economists became noticeably less “dismal” and purportedly more “scientific,” believing that such “macroeconomic” interventions could be calibrated to “tame business cycles” in part by transferring or defaulting on war debts. This was complemented by “microeconomic science,” the recent objective of which has been to prove that individuals aren’t always perfectly rational (and by inference in need of paternalistic political protection and direction). Macroeconomists contend that this psychological defect is contagious, conjuring irrational mobs running on banks (or attending Trump rallies).