in stereo where available
From the category archives:
Via the AP:
“As we know, the global financial crisis originated neither in Russia, nor in Greece or Europe — it came from across the ocean,” Putin said.
“In the United States, we see the same problems — massive foreign debt and budget deficit,” he said.
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The Special Inspector General’s report on TARP has been released from embargo. It concludes that TARP was unsuccessful, and even its (debatable) short-term corrections are overshadowed by the extent to which it has returned the economy to its previous bubble state — “we are still driving on the same winding mountain road, but this time in a faster car.”
From the executive summary:
The substantial costs of TARP — in money, moral hazard effects on the market, and Government credibility — will have been for naught if we do nothing to correct the fundamental problems in our financial sys- tem and end up in a similar or even greater crisis in two, or five, or ten years’ time. It is hard to see how any of the fundamental problems in the system have been addressed to date.
- To the extent that huge, interconnected, “too big to fail” institutions contributed to the crisis, those institutions are now even larger, in part because of the sub- stantial subsidies provided by TARP and other bailout programs.
- To the extent that institutions were previously incentivized to take reckless risks through a “heads, I win; tails, the Government will bail me out” mentality, the market is more convinced than ever that the Government will step in as neces- sary to save systemically significant institutions. This perception was reinforced when TARP was extended until October 3, 2010, thus permitting Treasury to maintain a war chest of potential rescue funding at the same time that banks that have shown questionable ability to return to profitability (and in some cases are posting multi-billion-dollar losses) are exiting TARP programs.
- To the extent that large institutions’ risky behavior resulted from the desire to justify ever-greater bonuses — and indeed, the race appears to be on for TARP recipients to exit the program in order to avoid its pay restrictions — the current bonus season demonstrates that although there have been some improvements in the form that bonus compensation takes for some executives, there has been little fundamental change in the excessive compensation culture on Wall Street.
- To the extent that the crisis was fueled by a “bubble” in the housing market, the Federal Government’s concerted efforts to support home prices — as discussed more fully in Section 3 of this report — risk re-inflating that bubble in light of the Government’s effective takeover of the housing market through purchases and guarantees, either direct or implicit, of nearly all of the residential mortgage market.
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Via The Big Picture comes news of a rather substantial revision of numbers from last November:
You may recall that consensus for November’s Durable Goods had been +0.5%. The reported data was lighter than expected at +0.2%. Looking at the revisions the Census Bureau has now incorporated into the data, we see that November actually printed at -0.7%.
The critical point is that this would represent two consecutive months of negative growth – a feat not accomplished since last January. For the record, the swing of more than 1% was officially attributed to a “processing error.”
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I’ve previously covered the danger of attributing meaning to a forecast which is obviously based on little or no information. In that case, it was the manufacturing survey, which one might dismiss as a more obscure measure. Recently, however, Ken Houghton has written a pair of posts on inflation forecasts that bring me back to that argument.
In his first, he presents a study that seems to show that, indeed, inflation expectations tend to assume that the future will look just like the present:
Again, this does not surprise me, as the futre expectation of a random walk is its present value. In the second post, the time series of inflation vs expectations is presented:
With the additional dimension of time, I can see a simple heuristic for inflation expectations: consumers think that inflation will stay at roughly the same level that it is on any given day, with some slight reversion to the Fed target, unless inflation is currently below the target, in which case they think it will rapidly bounce back to – or above – that level.
You can see the inflationary spikes in 2006 echoed in the 2007 forecast; the sharp 2008 increase and subsequent fall are mirrored in the 2009 forecast for the time they remain above the target, at which point they halt their slide.
These charts tell me two things. First, that consumers have very little insight into future inflation levels, to the point that they are unwilling to even choose a simple number like 3% and prefer instead to say that the future level will be similar to today’s. Second, that consumers have blind faith in the Fed’s ability to keep inflation at or above its target level – even in the face of evidence against that power.
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A long time ago, when I was first learning to manage my finances, my dad instructed me to prepay my credit card. This effectively transformed the credit card into a debit card by running a positive balance on the account. It was a great learning mechanism because it still required me to make monthly payments, but provided a cushion in case I missed one or made a mistake. In my father’s mind (and I agree), the few dollars I was losing in interest opportunity costs were more than made up for by a lengthy credit history with no late payments.
These days, I would never ordinarily prepay any of my cards. Just the opposite, in fact – I schedule payments for the last possible day. The economic rationale is simple: positive credit card balances don’t earn any interest, therefore I want to hold on to my cash for as long as I can. Occasionally, however, I send the credit card companies a little extra cash. The most common reason is also (believe it or not) economically rational: consumption smoothing. For example, I prepaid part of my October balance in September, anticipating an abnormally high balance that month (thank you, California trip). The net result after two months was the same, but there was no month in which I had to make a particularly large payment – and that’s easy on the mind.
So imagine my surprise today when I went off to make my first payment on my Discover card and the site informed me of the following (emphasis mine):
A credit has been applied to your Account since your last statement was posted. This credit has reduced your overall Discover Card balance.
Since you may not make an online payment for more than your current balance, we are showing you the Current Balance instead of your Last Statement Balance.
I found that very surprising (enough to write about, anyway!) – you would think, especially in this economic climate, that credit card companies would love to receive cash in advance on which they have no obligation to pay interest. I think that’s especially true because there’s a chance I might not use up my positive balance for some time, effectively giving the company an extended interest-free loan. So why would they ban this practice?
My theory is that their view is exactly the opposite of my father’s – by preventing customers from prepaying, they increase the probability of a customer paying late. That, in turn, allows the company to levy late fees which are far more lucrative than a few bps of short-term interest (at today’s levels).
Any other thoughts on why prepayments would be explicitly prohibited?
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Following the lead of an FT article last week, FT Alphaville went exploring ETC’s (exchange traded currencies) and noted (emphasis mine):
As for the investor… it means a potential upside scenario of receiving all of the performance of a currency index, for relatively low management fees, but without any interest or dividend (no carry trade here then).
The bold phrase prompted Felix Salmon to wonder how an ETC could “provide exposure to local interest rates” (as stated in the original article), when the follow-up claims there’s no interest at all? Felix tracked through various prospecti and documents in search of an answer, but couldn’t get a clear description of the ETC’s exposure. The closest he came was this, from Morgan Stanley Foreign Exchange (MSFX) indices documentation:
For the Total Return versions of the MSFX Indices based on the deliverable MSFX Currencies, in order to replicate the return of a constant fully collateralized strategy, the related MSFX Index will accrue interest daily at the One-Month T-Bill Rate… Hence, the daily return on the related MSFX Total Return Index will be computed as the sum of the MSFX Currency return and the One-Month T-Bill return.
To which Felix notes:
There certainly doesn’t seem to be any mention of local interest rates there.
And so both Felix and FT Alphaville concluded that despite having currency exposure, these securities can not replicate the carry trade. But this morning, Felix posted that ETC’s do in fact have sensitivity to local interest rates and, by extention, the carry trade.
I’m a bit surprised that this has taken so many words and posts to resolve. I think everyone needs to step back and review the basic mechanics of these products rather than go chasing details Here are a few key definitions:
FT Alphaville was correct that the ETC’s do not pay any interest or dividends. However, because they are total return indices, they were incorrect that this eliminates the carry trade.
Felix was correct that the documentation made no mention of local interest rates, but that’s a technicality as he failed to appreciate that interest rates and exchange rates are two sides of the same coin, particularly because total return indices were used in the absence of distributing interest payments.
When you borrow yen to lend dollars, you are earning a dollar interest rate and paying a yen rate; the differential (according to interest rate parity) corresponds to the exchange rate and would normally erase itself if the BoJ didn’t keep rates so low. Thus, the return on that yen trade corresponds to the difference between local and domestic interest rates. Finally, adding the T-Bill return on top of the exchange rate return means that the ETC is equivalent to investing in the currencies themselves, interest payments and all. And that’s it.
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I found this example particularly interesting, in particular because of the media attention heaped upon the twin positive readings of the ISM and construction spending numbers which were released yesterday morning.
Construction spending was expected to decline -0.2%, but instead rose 0.8%. By now you can guess the rest: the previous month, which had been reported as an increase of 0.8%, was revised down to -0.1%. Growth was certainly not explosive despite reports to that effect; rather than beating expectations by a massive 1%, the final index level is just 0.1% better than anticipated over the two months.
With revisions of this magnitude, one can either side with the conspiracy theorists – which might be a little extreme – or simply doubt the sincerity of any of these numbers as they swing wildly from month to month and have margins of errors larger than themselves.
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Front page of today’s WSJ: Fiat Models to Drive Chrysler.
On the plus side, the Alfa Romeo brand will be making its way to our shores.
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On the surface, the pre-purchase looks pretty good. As the salespeople point out, “it’s 20 cents below the pump!” But the small print is that it isn’t $2.89 per unfilled gallon; it’s $2.89 per gallon in your tank, period. If you have a 15-gallon tank but only use one gallon of fuel, you are still paying for 15 gallons of gas. So this deal only makes sense if you know at the time you rent that you will be returning the car with less than 7% of its tank remaining – the point at which the 20 cent savings becomes meaningful. (We ignore the opportunity cost of convenience.) Since I sincerely doubt anyone can reliably predict the future level of their gas tank, I can’t imagine who is taking this deal. Nonetheless, the fact that it’s offered means someone must be biting…
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