The EMH Following the Mother of All Typos
Phil Levy on the return of efficient markets:
One of the great memes to emerge from the financial crisis was that economists had no idea what they were talking about. After all, professional economists had urged deregulation and faith in markets; an internet full of amateur economists could easily see that such misguided nuggets of advice were solely responsible for all the woe that ensued.
This analysis was always a bit problematic. First, we may need a bit more perspective to properly attribute causality in the crisis. The snap analyses have been politically convenient, in that they have supported snap policy responses, but they have their flaws. For example, what about Fannie Mae and Freddie Mac? These were hardly paragons of unfettered market extremism and they were central to the housing bubble and to the cost of the eventual government bailout. I know firsthand that this was a crisis foretold by economists, since I served as a senior staff economist for Greg Mankiw when he chaired President Bush’s Council of Economic Advisers. Greg, working with excellent economists like Karen Dynan, now of Brookings, was vocal about the dangers posed by these government-sponsored enterprises and helped formulate proposals for reining them in. Congress blocked the proposals.
posted on 08 May 2010 by skirchner in Economics, Financial Markets
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The Market Believes the RBA is Targeting House Prices
The weighted average of capital city established house prices rose a Steve Keen-busting 4.8% q/q and 20% y/y for the March quarter, with gains in Sydney and Melbourne in excess of 20% y/y. This saw three-year bond futures savaged by around 7 basis points and the implied probability of a 25 basis points tightening from the RBA tomorrow surge from around 50% to around 65% on iPredict. The ugly 3.4% annualised result for the trimmed mean of the TD-MI inflation gauge released an hour earlier should be more important for the RBA’s deliberations, but it is house prices that are grabbing the market’s attention.
posted on 03 May 2010 by skirchner in Economics, Financial Markets, House Prices, Monetary Policy
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The RBA’s Perception Problem
Regardless of whether the RBA still backgrounds journalists on the monetary policy outlook, the perception that it does so remains alive and well in financial markets. Yesterday’s column by Terry McCrann confidently declared that ‘the Reserve Bank is all-but certain to deliver its third successive interest rate increase next Tuesday.’ At the same time, the implied probability of a 25 bp tightening priced into inter-bank futures rose from around 32% Wednesday to around 48% Thursday. There was a similar increase in the probability of a tightening on iPredict.
This suggests that the market doesn’t believe RBA Governor Glenn Stevens’ denial that the RBA leaks, although that denial was couched in very narrow terms. Of course, current pricing also implies that the market doesn’t have complete confidence in Terry McCrann either, but the change in market pricing is still significant.
Chris Joye speculates that this might be part of a RBA sting operation designed to finally put to rest the idea that the RBA leaks. Yet even if the punditocracy is deliberately wrong-footed on this occasion, it may not be enough to change market perceptions. When I worked in financial markets, I was often asked by clients whether I had ‘contacts’ at the RBA, with the clear implication that anyone who did was more likely to have the inside running on monetary policy. I always thought these clients had a greatly exaggerated view of the extent to which any such contacts might be useful in calling the interest rate outlook and the amount of media and other backgrounding that actually takes place. But that perception, even if exaggerated, is still a problem for the integrity of monetary policy.
UPDATE: Friday’s Reuters poll has the median financial market economist giving a 60% chance to a 25 bp tightening on Tuesday. Not quite the ‘all-but’ certainty expressed by McCrann.
posted on 30 April 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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Why the Financial Reform Bill Will Help Rather than Hinder Goldmans
The always insightful Eric Falkenstein:
Blankfein is a crony capitalist, begging for more ‘regulation’ because he knows that a 1300 page bill basically only helps those with connections and extant massive legal infrastructure, and hurts potential competitors who merely have good ideas
posted on 29 April 2010 by skirchner in Economics, Financial Markets, Rule of Law
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Goldman Sachs and Gangster Government
Michael Barone highlights the real lesson from the fraud case brought against Goldman Sachs:
Republicans have been accurately attacking the Dodd bill for authorizing bailouts of big Wall Street firms and giving them unfair advantages over small competitors. They might want to add that it authorizes Gangster Government—the channeling of vast sums from the politically unprotected to the politically connected.
That can boomerang even against the latter. Goldman Sachs employees gave nearly $1 million to the Obama campaign and $4.5 million to Democrats in 2008. That didn’t prevent the Goldman from being shoved under the SEC bus. Gangster Government may look good to those currently in favor, but, as some of Al Capone’s confederates found out, that status is not permanent, and there is always more room under the bus.
Eric Falkenstein asks whether investments banks are committing fraud by selling State of California debt:
I bet all of the major investment banks are facilitating debt issuance by the State of California and its various agencies, counties, and municipalities. I bet also there is a small but spirited set of shorts, trying to make money off of the inevitable bankruptcy. With hindsight it will be obvious, and everyone currently buying California-related debt will develop amnesia and claim they never liked California debt, and were hoodwinked by greedy bankers.
At that point, should all the investment banks be liable? If so, is every bank facilitating California debt issuance committing fraud right now?
posted on 22 April 2010 by skirchner in Economics, Financial Markets, Rule of Law
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The SEC’s Long Bias
Holman Jenkins on the SEC’s prosecution of those who shorted housing:
you can’t go wrong betting on the media’s unwillingness to unwrap itself from the errors of hindsight bias—that bet by the SEC has paid off. But there are bigger fish being fried. For more than a year, certain knowledgeable bloggers and investigative reporters have argued that such deals—Goldman’s was hardly unique—exacerbated the bubble, with special focus on the activities of a Chicago hedge fund called Magnetar.
It’s true that such deals gave housing bulls an additional way to lose money. But to blame shorts for making the bubble worse comes close to saying salvation for the markets is to exclude participants who are bearish…
The SEC certainly understands the need for a rapid route to rehabilitation for itself if it hopes for a share of the power and budget up for grabs in the Senate debate over financial reform. If you don’t think this played a role in the suit it sprang on Goldman last week, we have a CDO to sell you.
Goldman will have to decide for itself if its business model can be defended in the court of public opinion. But let’s admit there’s an implicit long bias to the SEC’s case. Nobody would give a hoot if Mr. Paulson were the party who lost money. The SEC would never have gone on its hunt for something, anything, to hang a fraud case on.
posted on 21 April 2010 by skirchner in Economics, Financial Markets
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The Real Giant Vampire Squid
Sucking up $381 billion and counting, according to the CBO. Pete Wallison lays responsibility firmly at the feet of Barack Obama:
It was in 2005 that the GSEs—which had been acquiring increasing numbers of subprime and Alt-A loans for many years in order to meet their HUD-imposed affordable housing requirements—accelerated the purchases that led to their 2008 insolvency. If legislation along the lines of the Senate committee’s bill had been enacted in that year, many if not all the losses that Fannie and Freddie have suffered, and will suffer in the future, might have been avoided.
Why was there no action in the full Senate? As most Americans know today, it takes 60 votes to cut off debate in the Senate, and the Republicans had only 55. To close debate and proceed to the enactment of the committee-passed bill, the Republicans needed five Democrats to vote with them. But in a 45 member Democratic caucus that included Barack Obama and the current Senate Banking Chairman Christopher Dodd (D., Conn.), these votes could not be found.
Recently, President Obama has taken to accusing others of representing “special interests.” In an April radio address he stated that his financial regulatory proposals were struggling in the Senate because “the financial industry and its powerful lobby have opposed modest safeguards against the kinds of reckless risks and bad practices that led to this very crisis.”
He should know. As a senator, he was the third largest recipient of campaign contributions from Fannie Mae and Freddie Mac, behind only Sens. Chris Dodd and John Kerry.
posted on 20 April 2010 by skirchner in Economics, Financial Markets
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Constitutional Challenge to the Bailout of Greece
Law professors’ constitutional challenge to EU plunder:
Dr Karl Albrecht Schachtschneider, law professor at Nuremberg and author of the complaint, told The Daily Telegraph that he will be ready to file within days and will ask the court for an expedited procedure. A ruling could occur within a week, but may take as long as six months.
The complaint will argue that the rescue contains an illegal rate subsidy, threatens monetary stability as encoded in the Maastricht Treaty, and breaches the ‘no bail-out’ clause. Greece is clearly responsible for its own mess.
“It is a question of law. The duty of the court to defend the German constitution. They have no choice other than reaching a lawful decision. This may cause a great crisis in Europe but we already have a crisis,” he said.
He will ask the court to freeze rescue aid while the case is pending. There is a precedent for this. It ordered Berlin to halt implementation of the Lisbon Treaty while it reviewed the treaty last year. Such a move would cause havoc on Europe’s bond markets.
“This court hearing is going to be very dangerous,” said Hans Redeker, currency chief at BNP Paribas. “It could lead to Germany itself being catapulted out of the currency union. Once investors begin to fear this, there will not be single euro in further financing for the EMU periphery.”
Sounds like a plan!
posted on 16 April 2010 by skirchner in Economics, Financial Markets
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The Contradictions of Behavioural Economics
Andrew Ferguson on behavioural economics:
You can see how useful the notion of irrational man is to a would-be regulator. It is less helpful to the rest of us, because it runs counter to every intuition a person has about himself. Nobody sees himself always as a boob, constantly misunderstanding his place in the world and the effect he has upon it. Surely the behavioral economists don’t see themselves that way. Only rational people can police the irrationality of others according to the principles of an advanced scientific discipline. If the behavioralists were boobs too, their entire edifice would collapse from its own contradictions. Somebody’s got to be smart enough to see how silly the rest of us are.
I make related arguments in my review essay ‘Authoritarian Economics’.
posted on 14 April 2010 by skirchner in Economics, Financial Markets
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Bond Market Vigilantes No Check on Fiscal Excess
I have an op-ed in today’s SMH questioning whether higher inflation and interest rates are the most likely outcome from the fiscal policy excesses that have followed the global financial crisis. Classical liberals fret about rising inflation and interest rates, but this is not entirely consistent with their view that the expansion of the state is bad for long-run growth prospects, which could be expected to depress both. This is not necessarily good news for bonds, as it points to an environment of depressed returns across all asset classes.
The latest unsolicited review copy to cross my desk is Accelerating out of the Great Recession: How to Win in a Slow-Growth Economy, by two partners at the Boston Consulting Group. Like many business books, it is useful mainly for what it tells us about the zeitgeist. The sub-title says a lot about current expectations for future growth, but I was also struck by this recommendation from the authors:
Prepare for government intervention and changes in the external environment, which will likely include a reduction in consumers’ disposable income and restrictions in free trade.
If this is what sells business books, then we have a problem and it’s not higher interest rates.
posted on 13 April 2010 by skirchner in Economics, Financial Markets
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ASIC Shuts Down Betting on RBA Board Meetings and the ASX 200
ASIC is seeking to prevent Centrebet from offering betting markets on the outcome of RBA Board meetings and the ASX 200 index, on the grounds that the bets are derivatives within the meaning of the Corporations Act. Sinclair Davidson and Ian Ramsay both suspect regulatory protectionism is at work:
Professor Ramsay said ASIC may have turned its attention to the bookmaker following a complaint from a competitor after it set up a market on the ASX200 share price index in March.
This will simply divert betting interest to offshore markets like iPredict, which enjoys the support of the Reserve Bank of New Zealand.
posted on 11 April 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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The Biggest Bail-Out: Where’s The Outrage?
Matthew Richardson on the missing outrage over Freddie and Fannie:
There’s a chance that the support thrown at the rest of the financial sector—$465 billion of direct capital, $285 billion of loan guarantees and insurance of $418 billion of assets—isn’t all money down the drain. $175 billion has been returned, the loan guarantees look much safer, and the insurance program, mainly for Citigroup, has been terminated.
Even the poster child for financial excess, AIG, may be able to fully pay off the government if the housing market doesn’t deteriorate further or the economy substantially improves.
But the chances are slim to none that Fannie or Freddie will be able to pay back the funds. It is highly likely that taxpayers will lose well over $200 billion—and it may well pass $300 billion. When the history of the crisis is all written, these two institutions will turn out to be the most costly of the financial sector—worse than AIG, Citigroup or Bank of America/Merrill Lynch.
So where is the outrage?
It’s not the pay packages: Compensation at Fannie and Freddie was right up there with other financial firms. For example, in 2006 and 2007, as housing conditions were weakening and the crisis started, the CEO salaries of Fannie were $14.4 and $12.2 million, and Freddie were $15.5 million and $19.8 million.
As Eric Falkenstein has also noted, the losses attending Freddie and Fannie are equal to around 90 Nick Leesons.
posted on 30 March 2010 by skirchner in Economics, Financial Markets
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Glenn Stevens Goes Where Ian Macfarlane Feared to Tread
Former RBA Governor Ian Macfarlane took pride in never having given an on-the-record media interview in his 10 years in office. Macfarlane’s public appearances were about as common as those for your average thylacine. Macfarlane only drew attention to the problem by engaging in a post-retirement media blitz that sought to set the record straight on all the issues where he claimed to have been misquoted or misrepresented while Governor.
Stevens has more than doubled the annual number of public speeches that Macfarlane gave in his last full year as Governor. If the last two months are anything to go by, Stevens will double his own record this year. His senior officers have also been considerably more active in terms of public appearances.
In a further break with the RBA’s secretive past, Governor Stevens has even put in an appearance on the Sunrise program. David Koch is not exactly Kerry O’Brien or Tony Jones, but the program’s reach is much greater. It sets an important precedent, but could be taken further. As I have argued previously, the RBA Governor should be made to front a media conference after every Board meeting and CPI release. A Treasurer with half a brain would insist on it.
The Governor’s comments on house prices during the program were somewhat risky, in that they could easily give the impression that house prices are a target rather than merely one of many indicators for monetary policy. If the public think Stevens is targeting house prices, then the Bank will end up owning them (figuratively, not literally, as with the US Fed). A better strategy would be to go on highlighting the supply-side constraints on the housing market. The public is smart enough to figure out who is to blame for those.
posted on 29 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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The Irrelevance of Bank Interest Rate Margins
At least one journalist gets the irrelevance of bank interest rate margins when the Reserve Bank is explicitly targeting credit conditions:
This means that the Reserve Bank, rather than bank gouging, is effectively targeting and setting the interest rate charged to mortgage borrowers because this is what influences the demand for credit. If the 20-25 basis point increase in the banks’ net interest margin suddenly disappeared, the Reserve Bank would simply hike its cash rate by the same amount so as to return mortgage lending rates back toward their more normal 7 per cent-plus levels.
As Stutchbury notes, bank bashing is little more than an attempt by politicians to divert attention from the implications of their own policies for interest rates. At least one bank is privately telling its shareholders to brace for more political thuggery:
Westpac is under financial pressure to raise its interest rates but fears a political backlash, chief executive Gail Kelly has reportedly told a private shareholder briefing.
Mrs Kelly told the briefing political pressure from Canberra could make it tough for the bank to increase home and business loan interest rates ahead of the federal election, due later this year
Mrs Kelly might also care to explain to Westpac shareholders why it is donating money to political parties that are actively seeking to damage the bank’s franchise.
posted on 23 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy
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Robert Shiller: The Ivy League’s Steve Keen
Robert Shiller’s stock market advice is as useful as Steve Keen’s real estate advice:
Following Bob Shiller’s “over 20” rule would have kept you out of the stock market every single month from December 1992 to September 2008. All that time Shiller was presumably scolding investors, warning that “sooner or later” there would be a market downturn…
The permabears might make a plausible argument against buying stocks if they argued that a big spike in bond yields was imminent. But that would be inconsistent with their usual forecast of stagnation and deflation. So they’re still peddling the fallacy of “above average” multiples, as they were a year ago.
For the press to still be recycling Robert Shiller’s stale arguments against buying stocks in March 2009, despite what happened since, is a remarkable example of the media’s inclination to favor downbeat theories over any actual good news.
But as I note in my review of two of Shiller’s books, Bob has trouble staying on message when it comes to long-term investment advice:
Akerlof and Shiller…note in passing that ‘there has been one way, at least in the past, in which almost everyone could become at least moderately rich. Save a lot of money. Invest it for the long term in the stock market, where the rate of return after adjustment for inflation has been 7% per year’. This is not what Shiller was telling people in 1996 when he said that ‘long run investors should stay out of the market for the next decade’.
posted on 16 March 2010 by skirchner in Economics, Financial Markets
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