Friday, September 28, 2012

Repent, O Ye Bankers

Said the Bishop, in humbling homily:
"You bankers are quite the anomaly.
I'd like to convert you
To living in virtue,
Instead of behaving abom'nably."

The Wall Street Journal's Jason Zweig writes that the Church of England has called for "the financial industry [to] look within and search its soul." This call to soul-searching followed an invitation from the British parliamentary commission on the LIBOR-fixing scandal for public comment on how to reform finance. "The church calls for two striking steps," writes Zweig.
First, bankers should seek to build “a culture of the virtues” that would enable anyone working in finance to answer the question, “What would it mean to be a good banker?”... Second, the financial industry needs to apologize and repent.
The Rev. Dr. Malcolm Brown, director of the Church of England’s Mission and Public Affairs Council, elaborates:
It’s like shoplifting: Even if you put what you took back onto the shelf, you still did something wrong. Just restoring the status quo ante doesn’t give people the sense that trust has been restored. You can’t just put it back on the shelf; you have to admit that the way things were done was wrong.

Thursday, September 27, 2012

Overheard in the Boardroom

"We took a non-core operation
And spun it off, free of taxation.
In time it so grew,
We repurchased it, too,
In the interest of world domination."

Glencore, the giant international commodities company, has been in the news lately with its offer to merge with Xstrata, the giant international mining company. Xstrata was created ten years ago as a spin-off of Glencore's then-small coal-mining operations, with Glencore retaining a 34% stake. In the intervening time, through a series of acquisitions, Xstrata has grown to a market capitalization of £28 billion ($45 billion), 20% greater than that of its "mother".

I have to admit that M&A is not my forte, and I wondered why a company would spin off a division, only to buy it back ten years later. One answer may lie in the fact that the spin-off, or IPO of a division, comprised a means for Glencore to realize the the division's value without actually selling it directly to another party, which would have incurred a tax liability. Having created publicly traded shares in a tax-free transaction, the new mining company had a currency with which to effect acquisitions. It could then grow to a size at which it could form a world-beating competitor as part of Glencore once again. Neat trick, provided one has the patience to wait ten years.

Tuesday, September 25, 2012

Day of LIBOR Reckoning

Said a banker: "We used to condone
The rigging the cost of a loan,
A benevolent practice
'Til many attacked us,
And now we must humbly atone."

The LIBOR rate-rigging scandal slowly rolls on, and by all appearances will continue to do so for some time. Bloomberg reports that management of RBS condoned and participated in the manipulation of the London Interbank Offer Rate, beyond the four traders who the bank has fired. And why not? “This kind of activity was widespread in the industry,” said David Greene, a senior partner at law firm Edwin Coe LLP in London. “A lot of the traders didn’t consider this behavior to be wrong. They took it as the practice of the trade. This is how things operated, and it seemed harmless.” Canadian regulators are currently pursuing legal action against, besides RBS: HSBC Holdings Plc, JPMorgan Chase & Co., Citigroup Inc., Deutsche Bank AG, as well as interdealer brokers ICAP Plc and RP Martin Holdings Ltd.

To any interbank traders, bank managers and all others beginning their Day of Atonement at sundown tonight, Dr. Goose wishes you an easy fast.

Monday, September 24, 2012

Tale of the Taylor Rule

There's a model of rate calculation,
First advanced in the Great Moderation,
That would have the Fed set
The cost of our debt
Based on output as well as inflation.

Then one of those Keynsian guys
Came and asked: "Do you think it is wise
To posit, post-crisis,
The worst is that prices
May lag, as the model implies?"

"A recession of untold ferocity
And slow monetary velocity
Demand a new means
To grease the machines,
And yours lacks the needed viscosity."

The Taylor Rule is one of those economic concepts of which I often hear mention, but on which I rarely focus. Created by Stanford professor John Taylor and others in the early '90s, the Rule would have the Federal Reserve raise (or lower) the base interest rate by about 1.5 percentage points for every one-percentage-point change in inflation. A 1% point change in GDP would call for a 0.5% point change in rates. (For those who appreciate the beauty of algebra, the Taylor equation below is explained in the link above.) Depending on which economist you talk to, Prof. Taylor has given us either a useful rule of thumb, or an article of faith.

This weekend, I was absorbed by a blog post from University of Oregon professor Mark Thoma, which questions adherence to the Taylor Rule orthodoxy in these days of deleveraging-driven Great Recession. In the Economist's View, Prof. Thoma and others argue that it's silly to hold the Fed to a rule that assumes no economic frictions except for "mild price stickiness." Evidently, the Taylor Rule would have the Fed setting rates much higher than zero, but even future Nobel Prize winners should know that unquestioning adherence to a model may have adverse real-world consequences.

Thursday, September 20, 2012


Narayana Kocherlakota President Federal Reserve Bank Minneapolis Fed
An economist known to propound
A theory he thought to be sound
Ignored a taboo
By changing his view
When facts that disproved it were found.

"You have to learn from the data," says Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis (pictured at right). This, he says in an interview with The Wall Street Journal, is why he set aside his concerns regarding "structural unemployment" and came to support the Fed's easing efforts more strongly. Structural unemployment results when the jobless lack the skills or mobility to fill open positions, while cyclical unemployment merely reflects a temporary economic downturn. Mr. Kocherlakota has been studying the problem of structural unemployment and concluded that it is less important than he previously espoused. In fact, he now believes that the Fed's most effective course is to keep interest rates low until the jobless rate falls to 5.5%.

The Minneapolis Fed president's comments, first conveyed in a speech on Thursday, appeared to move him from hawkish to the dovish side of the Federal Reserve board. However, Mr. Kocherlakota's public change of mind also serves as a reminder of the silliness and artificiality of "sides" in questions as complex as growth, inflation and employment.

MBA Cost/Benefit Analysis

"When the market was anxious and tense,
An MBA seemed to make sense,
But a growth outlook that
Is still very flat
Makes B-school a lavish expense."

Business school applications have fallen 22% worldwide from last year's levels, apparently due to the uncertainty bred by prolonged economic weakness. The flaccid recovery makes the expense of an MBA, coupled with two years' foregone income, look like a risky bet. One exception: my alma mater, the Stanford Graduate School of Business, saw a 1.5% increase in applications. Stanford has re-emphasized the applicability of its management training to a broad range of business, public and social issues, perhaps tapping into a strain of idealism that looks beyond a weak economy. Then again, it could just be the proximity to $AAPL and $FB.

Tuesday, September 18, 2012

Garden State Foreclosure Rate

New Jersey foreclosure delinquency robo signing
Said a realtor, scanning the rows
Of colonials, shacks and chateaux:
"Though it's not plain to see,
Ev'ry eighth mortgagee
May discover the bank will foreclose."

Bloomberg reports that New Jersey has overtaken Nevada to win second place in the nation's delinquency derby. With a mortgage delinquency rate of 12.7% (up 1.3 points over last year), the Garden State still has much ground to gain before reaching Florida's winning 17.5%. Aside from the generally tough economy, and regional factors such as the financial industry's job losses, the surge in our delinquent mortgages here in New Jersey is driven by a slowdown in the state's foreclosure process. Foreclosures were effectively halted in December 2010 by a state court demand that such procedures be based on a personal review of each case, as opposed to "robo-signing", in which assembly lines of workers issue stacks of documents. The result is that "New Jersey’s judicial review of all foreclosures, which delays seizures to help borrowers, threatens to hold down prices for years as properties remain subject to repossession and then may be sold at a discount," according to Bloomberg.

Monday, September 17, 2012

Let Them Eat Vouchers

Unguarded remarks are the bane
Of many a White House campaign;
It's hard to promote
The popular vote
From people you clearly disdain.

For example said Governor Romney,
The Republicans' President nom'nee:
Will never consent
To pull their weight in our econ'my."

While confiding in generous friends,
Mr. Romney ineptly offends,
Since half of the tax-free
Are elderly, actually,
On whom his election depends.

Several months ago, Mitt Romney held a candid Q&A session with well-heeled supporters at the Miami home of hedge fund manager Max Leder. In refreshingly (for him) blunt terms, Gov. Romney discussed the strategy and tactics of his campaign. In one point, however, Mr. Romney was a little too blunt, asserting that President Obama's core support derives from the 47% who pay no federal income taxes and purportedly expect a litany of free government services. "My job is is not to worry about those people," Romney said. "I'll never convince them they should take personal responsibility and care for their lives."

If you're not too stunned by a Presidential candidate dismissing half the country as freeloaders, consider the following:

  • The original video of Governor Romney with his donors, published by Mother Jones; 
  • An analysis by Slate's Dave Weigel of why "the 47%" are not who the Governor thinks they are; 
  • The National Review's Ramesh Ponnuru on why conservatives need to let go of the "47%" meme. 

Friday, September 14, 2012

Message from the Fed

"To counter employment fragility,
We promote cheaper funding ability,
But investors who yearn
For a decent return
Must accept more default probability."

The Fed Open Market Committee announced the details of its latest stimulus program on Wednesday, and it's a doozy: under the 3rd round of quantitative easing, the Fed will purchase up to $40 billion a month of mortgage bonds and Treasuries, in addition to its $45 billion of monthly machinations under the Operation Twist program. This massive QE3 intervention is intended to lower long-term interest rates, as the Fed long ago did for short-term rates. Chairman Bernanke and colleagues hope to drive the 10-year T-note, currently yielding 1.75%, back to its July low of 1.38%.

For bond investors, all this rate compression inflames an already acute yield pressure. Those who want to earn an attractive yield must either shift into riskier bonds, or reduce their fixed income allocation in favor of stocks or other more volatile asset classes. As one CIO expressed it to the Wall Street Journal, retail investors "are practically walking around in a daze; they don't know what to do. There is no safe yield out there, so they are redefining what is safe, which is a dangerous thing to do."

Thursday, September 13, 2012


It's expected the FOMC
Will finally enact QE3,
Prodigiously trying
By means of bond-buying
In some way to boost GDP.

If 500 billion is loosed,
There's a zero-point-one percent boost
In the rate of employed,
Which may leave one annoyed
With the gain this investment produced.

"Economists are skeptical about the benefits of another round of bond-buying by the Federal Reserve," writes Phil Izzo in the Wall Street Journal, but nearly all of them expect it, anyway. QE3, the third round of quantitative easing, will comprise more buying of Treasury and mortgage bonds, in a further attempt to reduce long-term interest rates and boost economic activity. Within the economic community, however, expectations for QE3's effectiveness could hardly be lower. 47 forecasters surveyed by the Journal estimate on average that, for every $500 billion in bond purchases, we can expect a 0.1 percentage point drop in the unemployment rate and a 0.2 percentage point increase in GDP. At least there will be no harm done: the group expects inflation to tick up by only 0.2 percentage points.

Wednesday, September 12, 2012

Momentous Decisions

A decision of global import,
Of the market-determining sort,
May sometimes be posed
For the judgment of those
Who make up a council or court.

Though everyone knows how it has to be,
Since there's only one way to vote ration'ly,
The markets are all
Completely enthralled
By the spellbinding risk of catastrophe.

Today, the financial world is enthralled by two such momentous decisions

  • In Germany, the Federal Constitutional Court in Karlsruhe must determine whether the European Stability Mechanism may proceed; i.e., whether Germany may participate in it. Everyone expects a resounding "Ja" from the court, as a euro-collapse may well be the consequence of a "Nein" decision. At the same time, the court's upholding the ESM does not mean business as usual, as it would set in motion a process that may well end in a loss of German sovereignty to some form of European political union. 
  • Meanwhile, here at home, the Fed Open Market Committee is expected to end its September meeting with an announcement of QE3, the third round of quantitative easing. Intended as a new round of economic stimulus, QE3 is already having an effect on the market before it's enacted, but it is not clear that a new round of Fed bond-buying will move the dial on the unemployment rate. 
Regardless, it appears that New York, London and Tokyo have already decided what Washington and Karlsruhe will do. Shares are up and the dollar is down in anticipation.

Monday, September 10, 2012

Out of the Labor Force

Labor force participation rate trend
Said an analyst, closely critiquing
The job market trends that are peaking:
"One is struck once again
By the outflow of men
From the ranks of employed or jobseeking."

"This development's long been projected
With retiring boomers expected,
But nothing so strong
Came to push it along
As the 2008 fiscal wreck did."

"Whereas once the laid-off might be prowlin'
For jobs from the ads they'd been scourin',
Many downsized afresh in
The current recession
Are optin' for throwin' the towel in."

Last Friday's non-farm payroll data incited more than the usual discussion for the fact that the unemployment rate declined even as more people were not working. This prompted much discussion (including limericks) of the labor force participation rate, which has declined sharply since 2008. The Atlantic's Derek Thompson anticipated this discussion when he asked earlier in the week: "Why Are So Many Men Dropping Out of The Workforce?" Not only has the LFPR declined in the last few years, but men's participation has been in decline for three generations.

Since the 1950s, men have slowly flowed out of the workforce as women have flowed in. Some of this male outflow stems from an aging workforce headed into retirement. In the Great Recession, older men may look pessimistically at their job prospects and decide, in many cases, that their wives' incomes and their social benefits comprise an acceptable fallback position. Thompson concludes that "the combination of an aging workforce (which we cannot control) and a weak economy (which we can control) has tugged down the participation rate, which in turn has tugged down the unemployment rate -- and threatens to make us poorer in the long term."

Saturday, September 8, 2012

Watch That Denominator

A fall in the joblessness rate
Would normally seem to be great,
Excepting, of course,
When there's less labor force,
Deflating the weight of that rate.

When the August unemployment rate was announced on Friday, its decline from 8.3% from 8.1% may have seemed like good news. In reality, the employment data were disappointing, because the number of nonworking people has actually increased. The growth in non-farm payroll employment of 96,000 fell short of the 
125,000 consensus forecast; neither did it meet the rate needed to accommodate new entrants into the job market.

However, not all nonworking people count as "unemployed" because the federal statistics only tally those who are working or actively seeking work. This is the definition of the labor force, which is divided into the number of unemployed job-seekers to give the unemployment rate. When the jobless become discouraged and stop looking for work, they are no longer considered "unemployed" or part of the labor force. Thus, they decrease both the numerator and the denominator of the unemployment rate by the same number, which lowers the rate. It is therefore also important to monitor the labor force participation rate, i.e., the labor force divided by the working-age population.

As shown in the graph, the labor force participation rate remained fairly constant at around 66% during the Bush years, until the onset of the financial crisis in the fall of 2008.  At that point, labor participation began a decline that has continued in the Obama years.  It now stands at 63.5%. A true recovery will have to bring those lost participants back into the labor force.

Thursday, September 6, 2012

DNC 2012

If rhetorically giving 'em hell
Marks a candidate bound to do well,
Then the ultimate dream
Of a Democrat team
Is comprising of Bill and Michelle.

The team of Obama and Biden,
To voters who still are decidin',
Did forcefully ask
To finish the task
They began when to hell we were slidin'.

No disrespect to President Barack Obama, but he leaves this Democratic National Convention with his oratorical skills having been upstaged by the former President and the current First Lady. Mrs. Obama ignited in Charlotte's Democratic partisans a fire they didn't know they had, while Mr. Clinton laid out the economic case for re-election more cogently and stirringly than Mr. Obama himself has managed to do.

Now, as President Obama returns to the daily grind of campaigning against Mitt Romney, he can only hope not to be upstaged as well by the jobs data that came out this morning. Economists expected the non-farm payrolls to have increased by 125,000, while the unemployment rate was expected to remain at an unsatisfactory 8.3%. In the event, the rate fell to 8.1%, but that's bad news because it reflects a lower labor participation rate, against only 96,000 new jobs.

The Master

Said Clinton, in regal rapport
With the Democrats massed on the floor:
"I can better affirm
He deserves a new term
Than Obama himself has before."

Former President Bill Clinton, in nominating President Barack Obama for re-election at the Democratic National Convention, gave one of the greatest speeches of his political career on behalf of the man who bested his wife in 2008. Reaching out to the heads as well as the hearts of of the assembled delegates, Mr. Clinton repeatedly hushed the fired-up crowd to listen to his deconstruction of last week's Republican convention attacks.

The GOP argument, said Clinton, is simple: "We left him a total mess, he hasn't finished cleaning it up yet, so fire him and put us back in." The case for re-election? We're better off than when President Obama assumed office, said his predecessor, and “we believe ‘we’re all in this together’ is a better philosophy than ‘you’re on your own.'"

Tuesday, September 4, 2012

Back to School

An earnest young lady named Esther
Was beginning her freshman semester,
And her greatest concern,
In preparing to learn,
Was that school would financially test 'er.

Everybody complains about the high cost of a college education, but nobody does anything about it. Now, at least, one man has put forward a microeconomic explanation. Kenneth Gould lays out an intriguing price discrimination argument in the American Enterprise Institute's online magazine.*

Gould's point is that the financial aid system allows the providers (colleges) to learn how much the consumers (students) are willing and able to pay, and thus practice first-degree price discrimination using financial aid to set different prices for the same service (education).

First degree price discrimination occurs when normal markets are interfered with and producers are allowed to learn exactly what each consumer is willing and able to pay for the good or service. Using this data, all the producers set individual prices for each consumer, eliminating competition and forcing the consumers that are willing and able to pay a higher price to pay it. In this pricing scheme, those who are willing and able to pay only a lower price get a break. ... As it turns out, this seemingly humane aim has a fundamental flaw — the same flaw that afflicts all non-market based systems: When producers no longer need to compete, production costs always rise faster than they otherwise would.
*Note to reader: the word "intriguing", when used in this space, refers to an argument with which the writer potentially agrees but must regard skeptically on political grounds.

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