RealClearMarkets Articles

In the world of mortgage investors, the glorified days of the Salomon Brothers trading desk, with stories of John Gutfreund, Lew Ranieri and games of liar’s poker, are a distant memory. Instead, scars from the global financial crisis endure in hearts and minds. The painful memories include the collapse of Bear Stearns and Lehman Brothers and the implosion of America’s mortgage finance and housing sectors.

For better or worse investors in mortgage securities, like investors in other markets, look to the past to forecast the future. In the wake of the pandemic-led market convulsions, some now worry of the history of 2008 repeating itself in mortgage credit and housing. I believe such fears are ill-founded. To be sure, higher default rates and weaker housing prices are likely in the near term. However, I view the odds of a dire 2008-like scenario as remote.

As a manager of portfolios of residential mortgage credit, I often get questions about this asset class and the housing market from investors, homeowners and prospective home buyers. Today many people are trying to sort out what the surge in unemployment means for mortgage credit and housing values. Their questions typically take one of two forms: Does the near-term horizon threaten a 2008-sized contagion of mortgage defaults and housing depreciation? Or is this time different? In fact, this time is very different from prior down cycles, especially 2008.

Homeownership represents a major investment for most homeowners. Looking back through different recessionary periods, home prices have often proven resilient, especially when aggregated on a national level. In contrast, the credit meltdown of 2008 led to a 35% national decline in home prices. Some regions in the Southwest and Southeast dropped more than 50%. Thus 2008 was an anomaly among past down cycles rather than a precedent for the future. Furthermore, given shelter-in-place efforts to slow the spread of COVID-19, never in recent history has the home been so important to our daily lives.

During the COVID-19 pandemic, digital tools have become indispensable to millions of home-bound Americans. Information technology businesses have quickly created or refined systems for distance learning, teleworking, telemedicine, news dissemination, and e-commerce. Yet, despite these successes, there are new demands to regulate companies such as Amazon, Zoom, and Facebook. Companies that step up in a time of crisis should not be punished with aggressive government oversight.

Government-imposed lockdowns have stalled the economy and our lives by blocking us from physical movement. But we humans are adaptable. We’re substituting digital movements for physical ones wherever possible, and our new demands mean that our digital suppliers must rapidly expand and adapt.

And they have. Amazon hired thousands more workers and is prioritizing household staples and medical deliveries. Cable TV companies are handling 25% more internet traffic. Verizon reports a ten-fold increase in the use of collaboration tools by its customers, applications that enable customers to see and speak with colleagues, friends, and family. Zoom expanded to accommodate a 378% increase in video-conferencing. When uninvited guests began “Zoombombing,” Zoom adapted with new security measures.

How valuable are these responses to market demands? We undertook research in March to measure them. We extended the work of MIT economists Erik Brynjolfsson, Avinash Collis, and Felix Eggers who pointed out three years ago that the value of some of our most important digital services are missing from official estimates of the size of the economy, such as gross domestic product. In 2017 the missing value of Facebook alone was about $102 billion.

A friend commented he personally knew three people who died of coronavirus, none of whom knew or associated with each other, and none of whom had been in places with high rates of infection. The 9,610 reported US coronavirus deaths works out to about one death per 34,000 people, so it seems astronomically unlikely for one person to know three unrelated victims.

I had been thinking along the same lines with respect to celebrity infections and deaths reported in the news. There seem to be too many, relative to the population numbers. The chart below shows the number of “notable people” Wikipedia lists as dying each day in March. The blue line is deaths that don’t mention CoVID-19, the orange line is the total with CoVID-19.

CoVID-19 deaths obviously increased rapidly after the 15th, but there was also an increase in the blue line that almost has to be the result of the virus. The cause of death may not have been reported, or perhaps the case did not meet official criteria for CoVID-19 (for example, the person may have been weakened by the virus, but succumbed to another condition).

An average of 19 notable people died in the first ten days in March 2020, which is close to the average of 21 notable people who died each day in March 2019. But an average of 35 notable people died in the last ten days of March. It seems reasonable to assign those 16 extra deaths to the virus, meaning that for every 100 notable deaths from other causes, 84 notable people died as a result of the virus.

One of the challenging things about understanding the SARS-CoV-2 pandemic is the variety of seemingly conflicting projections from infectious disease experts, and the even greater variety of definitely conflicting reformulations of those projections from political leaders.

My sometime-collaborator Philip Tetlock has made a career studying the defects of expert judgements and, more important, finding ways to extract the actual expertise into useful forecasts. He’s currently exploring this with infectious disease experts and told me:

We had a very similar experience with epidemiologists: subjective probability forecasting was an alien exercise to them and they produced noisy, occasionally erratic, judgments. One solution is sharpening the disciplinary division of labor: (a) ask epidemiologists to offer explanations/models in language they are comfortable with (e.g., SIR or SEIR models); (b) ask superforecasters to translate explanations into implied probability estimates.

I unhesitatingly acknowledge that Phil and his team at the Good Judgement Project are the world experts in these matters. My career has been in gambling and financial risk management which gives faster and more streetwise solutions.

With all the dramatic public health and financial news of the last couple of weeks, thinking about ETF discounts may feel like rearranging the deck chairs on the Titanic. But these discounts provide us with an unprecedented window into financial markets in crisis, and are a natural experiment to test opposing strongly held theories of optimal regulation in a crash.

Exchange-traded funds hold baskets of securities, and I’m going to be looking at bond ETFs, which—of course—hold bonds. Shares of the funds trade on the stock market. Normally the price at which the ETFs trade on the stock market are close to the Net Asset Value of the underlying bonds. For example, if the fund holds $1 billion in bonds, and has 10 million shares outstanding, the shares should trade for about $100 each.

If the ETF price differs significantly from the NAV, certain dealers designated as “authorized participants” can either buy more bonds and put them in the fund in exchange for more shares—which they would do if the ETF traded at a premium to NAV, meaning the ETF shares sell for more than the bonds cost—or redeem ETF shares for the underlying bonds—which they would do if the ETF trades at a discount.

Over the last 12 trading days, we’ve seen ETFs trade at unprecedented levels of discount and—more rarely—premium. This is true for all kinds of ETFs, more for bond ETFs than stock ETFs.

“Money does not pay for anything, never has, never will. It is an economic axiom as old as the hills that goods and services can be paid for only with good and services.” – Albert Jay Nock

Though the dollar’s exchange value vis-a-vis gold, global currencies, indexes, seashells, and any other alleged benchmark has never been part of the Fed’s portfolio, the fact that current Federal Reserve Board nominee Judy Shelton has long expressed support for a gold-defined dollar has propelled the “gold standard” back into the economics discussion. Some who support a commodity anchor for the dollar side with Shelton, while all-too-many who disagree with Shelton have dismissed the notion of a gold-defined dollar as the stuff of witless cranks.

Up front, count yours truly as an energetic supporter of Shelton and a return to a commodity definition for the dollar. About gold or the gold standard, it should be said right away that an ongoing problem with a gold standard is that all-too-many “witless cranks” support one without knowing what it is they’re supporting. These are usually the same individuals who tie every economic ill of the last 100 years to the Federal Reserve, who believe the Fed “monetizes” budget deficits, and who claim that the central bank was a conspiratorial creation of the Rockefellers.

I’m not one of them. And at risk of presuming to speak for others with whom I regularly discuss monetary policy with, I speak for those who view money in the way that Adam Smith did. Smith made the basic point in The Wealth of Nations that “the sole use of money is to circulate consumable goods.” Implicit in Smith’s reasoning was something that I and the others I presume so speak for understand as an historical truth: “money” wasn’t first a creation of government, plus it well predates central banks. Money was a logical consequence of producers seeking an objective agreement about value that would make it possible for producers to exchange with one another: I have bread and I want your wine, but you have no interest in my bread given your mouthwatering desire for the butcher’s meat.

Economic discourse would be a great deal more informative if it were broadly understood that no one borrows money. What they borrow is what money can be exchanged for. Always.

That’s why readers should always be skeptical when pundits and economists talk of “easy money” or “too much liquidity” care of some government entity like the Fed. Implicit there is that governments, by virtue of printing money or increasing so-called “money supply,” can increase the supply of goods available for borrowing, and by extension, borrowing itself. Such a view isn’t serious. Only the private sector can increase borrowing or liquidity simply because all goods and services are produced in the private sector.  

All of this rates mention yet again given some comments Michael Bloomberg made about faulty lending that allegedly led to 2008. Bloomberg was criticized for weighing in, at which point conservatives and libertarians trotted out their own familiar arguments about what happened almost twelve years ago.

One conservative economist blamed Fannie Mae and Freddie Mac for making it possible for lenders to make “sloppy loans” since they “knew those mortgages could be bundled into securities and sold” to the two quasi-governmental entities. This stance is a popular one among conservatives, but it ignores a rush into housing that was global in nature, and that took place in countries where there was no Fannie or Freddie. After that, it's worth pointing out that housing soared in England even though the mortgage interest deduction was jettisoned there back in the 1980s. Housing boomed in Canada even though it’s long been very difficult for borrowers to access home loans there.

Over the past few years, no state has been more aggressive in pushing constitutional limits on its authority than California, most recently with its attempt to make national law on internet privacy. This effort is just a small part of a growing trend of states attempting to tax and regulate outside their borders.

Thus, it’s a relief when at least one state pushes back on California’s aggression, arguing that the Golden State’s regulatory power should end where its borders do. That’s the case with Arizona House Concurrent Resolution 2013, a bill in the state House of Representatives that would make it the Arizona government’s position that internet privacy regulation is the purview of Congress, not individual states.

Arizona’s legislature doesn’t bring this up idly. California’s landmark consumer privacy legislation, the California Consumer Privacy Act (CCPA), went into effect less than two months ago and threatens to impose crippling compliance burdens on businesses all across the country.

The CCPA set data privacy standards for businesses that transact in 50,000 or more Californians’ data, even if the business lacks any physical presence within the state. Given that this represents just 0.18 percent of the state’s adult population, this standard was always likely to ensnare a significant number of out-of-state businesses.

When Live Nation and Ticketmaster merged in 2010, many feared that the new giant would use its dominant position in the concert touring business to pressure venues into contracting with Ticketmaster, which now controls 80 percent of ticket sales at the nation’s largest venues. Those fears came true -- Live Nation Entertainment has since systematically and strategically attempted to control the entire ticket supply chain and the prices consumers pay.

The Department of Justice (DOJ) sought to limit the company’s attempts to bully venues seeking Live Nation music talent to use Ticketmaster for ticketing through conditions included in the merger approval consent decree. Christine Varney, the then-Assistant Attorney General for Antitrust, stated in 2008 that the DOJ was concerned that “the merger posed a threat to growing competition in primary ticketing” and that “it was this substantial lessening of competition that we concluded violated the antitrust laws.” Sadly, in the decade since the world’s largest ticketing company combined with the world’s largest concert promoter, tickets have become increasingly more expensive, more difficult for fans to access, and more difficult for fans to resell.   

In December 2019, the DOJ reported that Live Nation has “repeatedly and over the course of several years engaged in conduct that….violated the Final Judgment” that was supposed to “prohibit the company from retaliating against concert venues for using another ticketing company, threatening concert venues, or undertaking other specified actions against concert venues for ten years.”

The DOJ responded by extending the settlement five years, imposing $1 million fines for each future violation, and appointing an independent monitor. But even these measures don’t go far enough to protect music fans.

What do you do if you find your country in the midst of a currency war? For Brazil’s Finance Minister in early 2011 the response seemed clear enough. After all, it had been Guido Mantega who had made the initial declaration. Back at the end of September 2010, once it became very clear Ben Bernanke’s Fed was about to launch a second round of “massive” “money printing”, Mantega had gone before the world’s microphones and stated his outrage.

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”

From his perspective, one shared by many around the emerging market (EM) world, the purpose was textbook. The United States or Europe would attempt to get back up from the Great “Recession” on the backs of those other systems. At that early “recovery” stage, it was becoming obvious that something wasn’t right.

To begin with, how could it have been quantitative easing, what everyone assumes is money printing, if it had to be done twice? To the Brazilians and a great many more, the Federal Reserve was going to start beggaring all its neighbors to make up for its growing economic shortfall.

The Economics textbook says that a lower currency exchange rate equals stimulus. It makes your exports relatively less expensive against others on world markets, particularly when your currency is falling against the US dollar. As a consequence, your neighbors’ goods are disadvantaged.

It was sometime in December of 1984, and memory says it was a Friday night. The show was Nightline. Memory also says that on the aformementioned show legendary film producer Robert Evans was being interviewed. The only thing was that by 1984, and unbeknownst to yours truly, he was no longer legendary.

It had realistically been nearly a decade since Evans had been a bigger-than-life studio executive and producer, with his name or studio (Paramount Pictures) associated with classic films like The Godfather, The Godfather II, Rosemary’s Baby, Love Story, etc. And while he produced Urban Cowboy in 1979, the second half of the ‘70s wasn’t as kind to Evans. Once the head of Paramount, he’d been demoted to producer. In 1980 there was a cocaine arrest, there was a big budget box office failure titled Popeye, and then there was The Cotton Club.

That’s when I came to know of Evans. This most compelling of individuals was on Nightline aggressively defending a big budget film that those in the know had written off. Worse, the production had been overshadowed by the questionable money behind it, spiraling costs, and the possibility that Evans himself would have to declare bankruptcy over it. Goodness, an investor in this most star-crossed of films had been murdered. Though Evans still had enough juice to get on network television in order to desperately try and save The Cotton Club, his persuasive powers couldn't save the film.

Still, what a fascinating person. I never forgot Evans, only to eventually devour all manner of books about him or that featured him in later years, including but not limited to Peter Biskind’s all-time great history of the movie industry in the 1970s, Easy Riders, Raging Bulls, Brian Kellow’s Can I Go Now? (about ‘70s superagent Sue Mengers), not to mention Evans’s very own autobiography, The Kid Stays In the Picture. The latter ultimately became a cult favorite, particularly inside Hollywood, so much so that Graydon Carter later produced a documentary of the same name to visualize this most readable of memoirs.   

Many of America’s corporate and academic elites have united to advocate for a carbon tax.

With all the money and brains behind the self-anointed “Climate Leadership Council” (CLC) you would think it would be able to figure out ¾ the math is simple ¾ that a carbon tax will have no effect on climate. There are reasons they haven’t.

The CLC is undertaking a media and lobbying blitz to push for a $40-per-ton national carbon tax, escalating by 5% per year. The CLC calls this “the most cost-effective, environmentally ambitious and politically viable climate solution.”

A $40 carbon tax would immediately raise the price of oil by $17, or to about 133% of today’s prices. We’re told not to fret the price increase because the government will remit the tax back to taxpayers as a “carbon dividend.” Most consumers will get back more money via the dividend than they paid in the tax, says the CLC.

Many have written articles clamouring at and assailing the dreaded Public Debt of various municipalities, states, provinces and nations. When have economists, thinkers, politicians, and citizens not deplored the public debt and perceived burden inherent in these ornate pieces of paper issued and accumulating in ever greater amounts over the years? But is the Public Debt, so condemned and derided, the scourge all believe it to be?

In truth, the expanding public debt is no burden at all, whether public IOUs are passed along from generation to generation, or recalled and lenders repaid.

To grasp better the subject and settle the enduring controversy, one must turn to Ricardian Equivalence, a little known idea that confirms it makes no difference to resident citizens whether the government taxes or borrows to fund public expenditures.   

Suppose a government requires $100 for some public expenditure. It can tax or borrow to acquire the funds. If it tax, $100 leaves the bank accounts of resident citizens, specifically taxpayers, and the public good is supplied. If it borrow, again $100 leaves the bank accounts of resident citizens, specifically lenders, and the public good is supplied. Thus far there is no difference between Taxation and Borrowing.

In the Beltway, no inefficient policy deed goes unrewarded. That is an eternal truth illustrated well by the expansion of federal powers---at the expense of state and local authority---attendant upon efforts to ameliorate the adverse effects of prior policies to favor one set of energy technologies over others.

The latest example of this dynamic is a recent order from the Federal Energy Regulatory Commission (FERC) to the PJM Interconnection, a regional transmission organization that coordinates through auctions the purchase and movement of bulk power in 13 states and the District of Columbia. The FERC expansion of the “minimum offer price rule” (MOPR) will set a base price for all power sources in PJM’s capacity market, where generators bid to supply future market electricity demands, so as to offset the artificial competitive advantages created by state subsidies for wind, solar, and nuclear facilities.

States are subsidizing wind and solar power because of political pressures to increase the market share of “clean” electricity, notwithstanding the reality that there is nothing “clean” about those power technologies. Some states have implemented subsidies for nuclear generation as well in part because federal and state favoritism toward wind power in particular allows wind facilities to underbid (sometimes to negative levels) nuclear operators, which essentially must continue to produce electricity regardless of market prices on a given day.  

In short, traditional power generation sources like coal and gas plants often find themselves competing on a playing field decidedly not flat. This has led FERC to conclude that the state subsidies have distorted cost competition in the PJM Interconnection.

The Tax Cuts and Jobs Act (TCJA) is the signature conservative legislative achievement of the 21st century. Not only did 80 percent of taxpayers receive a significant tax cut, but the highest percentage of Americans in Gallup survey history report feeling they are better off financially than they were a year ago. Unfortunately, one crucial element of the tax reform law is in danger of being phased out in just a few years.

One of the most important provisions of the TCJA allows companies to immediately write off investments made in the business. This is a logical and beneficial provision — not only does it encourage investment, an economically productive activity, but there is no way for businesses derive any benefit without investing. This so-called “full expensing” approach in TCJA replaced long, complicated depreciation schedules with a simplified system that encourages capital investment.

But absent legislative action, the American tax code will default back to a complex and burdensome system that delays those tax write-offs for years. Under this approach, businesses must refer to a complicated system of recovering investment costs through the tax code over extended periods of time known as Modified Accelerated Cost Recovery System (MACRS).

If a business wants to take advantage of MACRS, they must consult cost recovery schedules that can draw out the depreciation period anywhere from three to fifty years, depending on “property class.” Navigating this bureaucratic quagmire can be a nightmare — prior to the TCJA, businesses spent over 448 million hours a year just to comply with these rules, for an estimated total of $23 billion in compliance costs to the American economy.

The European Data Protection Board recently closed a comment cycle on guidelines for the European “right to be forgotten” under the General Data Protection Regulation, or “GDPR.”  The new guidelines list the word “right” 15 times and “duty” 15 times, as rights and duties are easily created commodities.  Such is the supposedly profound role of self-envisioned government truth arbiters in the modern era.

Because of this supposed “right,” Europe today is not dissimilar to Oceania, the infamous Orwellian thought-control state depicted in 1984.  In the novel, protagonist Winston Smith spent his days doctoring newspaper articles and historical photographs, and in doing so literally rewrote history.  So too did Soviet workers during the reign of Joseph Stalin.  Even today, North Korea routinely engages in similar practices.

Thanks to the European “right to be forgotten,” this longstanding tradition of government censorship and historical revisionism is alive and well across much of the continent.  And if we’re not vigilant, it could spread to American shores too.

Europe’s descent into madness began in 2014, when the European Court of Justice initially found a modern “right to be forgotten” in European law.  As a result, individuals could petition Google to remove articles from its search results under a wide variety of circumstances.

Readers of this column are familiar with this historical truth, but it’s worth repeating in light of the ongoing conservative crack-up over Chinese communications giant Huawei. For clarity on the matter, it should be stated right away that if you’re selling a desirable good, you’re selling to EVERYONE.

For background on what’s blindingly basic, back in 1973 Arab country members of OPEC announced an embargo on the U.S. Crucial about this wholly symbolic gesture is that Americans consumed every bit as much “OPEC” oil during the embargo – and by some accounts more – as they did before it. That they did was a statement of the obvious. Though Arab OPEC members ceased selling their oil to us, those they sold to didn’t.

There’s no accounting for the final destination of any good. The previous truth explains why Apple iPhones are all over Iran, and why Mercedes-Benz cars, American music, and Nike shoes can be found in North Korea in the hands of those with means. Though Germany has an embargo in place against North Korea, and though the U.S. has trade embargoes against both countries, ownership of Apple, Mercedes and Nike products is global. Many of those owners aren’t constrained by what is once again wholly symbolic, and an all-too-typical gesture of economically confused political types. Oh well, just because they’re clueless about economics doesn’t mean readers should be.

Which brings us to the ongoing attempts by the Trump administration to suffocate Huawei. That these actions are nakedly protectionist doesn’t seem to concern the foreign policy establishment, along with all too many Republicans who would be writing opinion pieces similar to this one (minus the erudition, mind you….) if it were President Hillary Clinton vandalizing basic economics.

In The Great Successor, Washington Post reporter Anna Fifield’s very uneven and very poorly edited book about North Korean dictator Kim Jong-un, she indicated that among other things Kim passed his childhood days listening to Whitney Houston while frequently dressed in Nike garb. More modernly, Fifield reports that Kim brings an Apple MacBook with him when he travels on one of his many jets.

About what’s been written so far, some readers might be nonplussed. Didn’t the U.S. long ago impose a trade embargo on North Korea? If so, why does Kim enjoy very American plenty? The answer is simple: there’s no accounting for the final destination of any good. That U.S. companies are forbidden to sell inside North Korea is of no consequence when it's remembered that the feds do not control those whom U.S. companies are free sell to. So long as they’re selling their wares, U.S. companies are ultimately selling to North Koreans who desire U.S. products, and who have the means to purchase them. And how do North Koreans exchange goods and services, including that which is U.S. produced? According to Fifield, “the U.S. dollar is still the preferred currency for North Korean businessmen since it is easier to convert and spend.”

You read that right: the economy of one of the U.S.’s foremost “enemies” is liquefied by U.S. dollars. That the dollar facilitates exchange in Pyongyang, and that it does so without the help of the Federal Reserve, is a statement of the obvious. Simply stated, money is a consequence of production, not a driver of it. Individuals produce in order to exchange what they produce with others, which explains why the dollar factors into so much global trade. Precisely because the dollar can be exchanged for goods and services the world over, its role in global trade and investment is of the 90%+ kind.

All of which brings us to Judy Shelton’s nomination to the Federal Reserve board. Up front, what’s previously been said should exist as yet another reminder that the Fed’s presumed ability to influence economic outcomes is exponentially more theoretical than real. That the U.S. dollar liquefies the economy of this most econmically isolated country speaks to how overstated the Fed’s power is. Credible money finds production, period. That the Fed can’t limit dollars flowing to their highest use in North Korea should have even the mildly sapient questioning why so many pundits, politicians and economists focus so much on the Fed stateside. If the central bank can’t keep dollars from refereeing trade and investment in a police state, does anyone seriously think the Fed can “tighten” or “loosen” access to dollars in the U.S.? The question answers itself.

He was a bear who was surrounded by ducks, and so one day he decided to slaughter some ducks to show he was still a bear. That was how one Russian political analyst put the March 1998 sackings. The bear was President Boris Yeltsin who while nominally still in charge had long since been a shell of his former self. Outwardly aging and taking off for long stretches, much had been left to his Prime Minister Viktor Chernomyrdin.

Chernomyrdin was an old style apparatchik. He survived the fall of the Soviet Union in Yeltsin’s orbit and would serve him faithfully, some said well, out from the one desperate crisis until the doorstep of another. The early nineties transition from Communism was a disaster for the Russian people and the economy, and with financial noises plaguing much of Asia beginning in the fall of 1997 there were growing fears Russia could slide back into the abyss.

President Yeltsin fired his entire cabinet one day in March 1998. No warnings, no consultations. On a national television broadcast, Boris gave Russians few specifics, saying only that his ministers were, “lacking in dynamism and initiative, fresh approaches and ideas.”

Initially, Yeltsin had simply absorbed the role of Prime Minister. His time as that particular officeholder lasted but a few hours. Later that same day, he changed his mind and appointed Sergei Kiriyenko who had just been fired from his position as Minister of Fuel and Energy.