Carl from Chicago

Business executive interested in history, economics, taxation and energy policy.

Default Rates and Static Analysis

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As recently as a early 2007 ago there was very little “risk premium” between debt of varying quality. The risk premium is usually measured against US Government debt (Treasuries) of equivalent duration (i.e. a 5 year bond compared to a 5 year security). For instance, if the Treasuries were yielding 5%, then high-quality (at the time) corporate debt might be issued at 6%, with riskier debt as high as 9% (a premium of 4%).

At the time I wrote that this absence of a risk premium was unusual and meant that buyers of debt were being paid very little (beyond what they’d get for a risk-free government issue) for taking on the business risk tied to these often highly leveraged, cyclical businesses. As it would later turn out, these yields were far too low, and since have widened to historically high levels. For example, while Treasuries are around 5% now, “junk” bond yields for new issues are near 20%, which is an amazing premium of 15% or so.

Some analysts are saying that these yields are TOO high (i.e. the market is demanding too much for the level of risk that you are taking on). By their reckoning, companies would have to default at a rate that they didn’t even approach during the great depression in order to justify these yield levels. Others are recommending that this might be a good time to jump in at these levels.

While their calculations of required failures do indeed seem high, the analysts have failed to take one CRITICAL variable into account – the absence of liquidity – essentially they are only modeling the risk of default in isolation.

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Certificates of Deposit (CDs) In Your Brokerage Account

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There have been some recent changes on FDIC insurance limits for CDs and there is a (relatively) new way for time strapped investors looking to buy CDs, which is through a brokerage account. This method allows investors to pick from a variety of institutions online at a single place and receive the income in their brokerage account rather than physically go from place to place to purchase CDs and then receive a pile of paper at year end. There also is the ability to sell CDs in the market during the life of the CD (i.e., you could sell a 5 year CD 2 years into it) at either a gain or loss depending on the direction that interest rates have moved in the interim (down, you will have a gain, and up you will have a loss). You can keep it until maturity and always get what is promised, this is just another subtle opportunity. Read more if this topic interests you.

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Gentrification… and the Lie of History

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In the NY Times this weekend they had an article about a one man show by Danny Hoch. The topic of his show was gentrification, and how it impacted natives of New York City. In the article they reviewed him and he had the following quote:

“I did a lot of community arts work through the 90’s, really believing that we were making a difference socially…. Within the last 10 or 15 years, those communities have virtually been erased.”

On a seemingly unrelated line, there is a history of the neighborhood that I live in, the River North neighborhood in Chicago. Here is a link to a document summarizing River North history, notably its time as a manufacturing area called “Smokey Hollow”. This article summarizes the demographic changes in the Near North neighborhood of Chicago by decade.

These types of documents talk about the history of a neighborhood as if it was continuous, with links between each era. However, the reality of urban areas like River North (and the New York of Mr.Hoch) is really quite different. Aside from some projects just north of Chicago Avenue near Cabrini Green, the neighborhood has turned over to a degree that most US residents would find astounding. There are literally no individuals living in River North that were even here ten to fifteen years ago.

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Leverage and the Housing Bubble

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The housing bust has been well chronicled elsewhere and I won’t add much to it by summarizing it; let’s assume that readers of this blog know the outlines (and details) of the story. But while everyone has learned the (often bitter) lesson that housing doesn’t always go up, it also comes down, they haven’t fully digested other elements of the financial picture. High LEVERAGE on a flat or declining investment makes the “buy” vs. “rent” even more skewed away from “buying”.

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Re-visiting the Car

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While I dream about owning a Nissan GTR that I saw at the Chicago auto show, in reality I drive an old Nissan Altima about 10 years old. That damn car will run forever since I take decent care of it and my frugal nature won’t let me replace it without a valid reason.

As I drive around in my older car, however, I can’t help noticing all of the expensive cars out on the street. Right now it is Saturday night here in Chicago in River North, and lots of people are “cruising” up and down the major streets, seeing and being seen, in their tricked out cars.

The situation is the same even when I visit a poorer neighborhood. A relative of mine moved to Beverly, in the south side of the city, and no matter how you drive to get there, you need to go through some pretty rough neighborhoods. New and expensive cars are ubiquitous, even there.

Let’s think a bit about car economics. If you use $25,000 / loan at 48 months as a starting price point, and the average rate of 6.5%, you are paying about $600 / month.

However, that “minimum payment” model has gone belly up. Here’s why.

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