October 11, 2015

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When Things Started Going Wrong

A weekend topic on the housing bubble. USA Today, “In Phishing for Phools: The Economics of Manipulation & Deception by George Akerlof and Robert Shiller, the authors note that free markets are capable of generating unimaginable wealth and innovation. And yet, this system also ‘tends to spawn manipulation and deception.’ Because the goal of every business person is to get you to spend your money, they will often come up with ingenious ways of tricking you. This frequently results in consumers choosing things that aren’t very good for them.”

“The authors define the word ‘phish’ as “getting people to do things that are in the interest of the phisherman, but not in the interest of the target.” In other words, ‘phisherman’ are those businesses that are trying to get you to buy something that may not be in your best interest. A ‘phool,’ according to the authors, is ’someone who for whatever reason is successfully phished.’”

“The authors argue that phishing is one of the prime reasons behind the volatility of asset prices. Misleading accounting, media hype, investor sales pitches — these are just some of the ways that asset prices become inflated. When the inflated assets have been purchased with borrowed money, huge losses will eventually snowball and ‘then credit dries up; and the economy tanks.’ We experienced that back in 2008 and 2009, of course. Phishing hurts investors in a variety of ways.”

“By PAUL KRUGMAN Published: August 2, 2002″

“If the story of the current U.S. economy were made into a movie, it would look something like ‘55 Days at Peking.’ A ragtag group of ordinary people — America’s consumers — is besieged by a rampaging horde, the forces of recession. To everyone’s surprise, they have held their ground. But they can’t hold out forever. Will the rescue force — resurgent business investment — get there in time?”

“Consumers kept spending as the Internet bubble collapsed; they kept spending despite terrorist attacks. Taking advantage of low interest rates, they refinanced their houses and took the proceeds to the shopping malls. But predictions of an imminent recovery in business investment keep turning out to be premature. Most businesses are in no hurry to go on another spending spree. And those that might have started to invest again have been deterred by sliding stock prices, widening bond spreads and revelations about corporate scandal.”

“The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

From Bloomberg. “In a new note titled ‘The real cost of QE,’ Bank of America’s FX strategist Athanasios Vamvakidis takes a critical look at the U.S. central bank’s particular brand of unconventional monetary policy, and its changing relationship with financial markets. He contends that ‘excessive reliance on unconventional monetary policy’ is not without side effects, many of which are only now being felt in markets.”

“‘At some point during Fed QE, the markets started reacting positively to bad news. In our view, this is when things started going wrong. Bad news became good news for asset prices, as markets expected more QE by the Fed. Asset prices were increasingly deviating from fundamentals, as the markets were trading the Fed instead of the economic reality. This was clearly not sustainable.’”

“‘We should have known something is wrong. The Fed ‘taper tantrum’ could have been the first signal that QE had gone too far. The second warning may have been the across-the-board emerging markets sell-off that started in mid-2014, as QE tapering was coming to an end and the market started pricing Fed tightening, a sell-off that intensified substantially this year.’”

“He notes that despite the continued expansion of balance sheets at a number of central banks around the world, monetary policy conditions have tightened and liquidity has fallen. So what happens next? Vamvakidis contends that markets are embarking on a big readjustment: ‘The story of the year so far may be that of a negative feedback loop leading to a bad equilibrium. First, risk assets sold off expecting the Fed to tighten. Then, the sell-off went too far and started affecting the real economy, including in the US. Now, the Fed is not tightening as a result. However, postponing Fed tightening does not necessarily increase the demand for risk assets. This is a new regime, in which bad news is bad news. This is how it is supposed to be, but the adjustment back to normal has not been and is not going to be smooth, in our view.’”

Bits Bucket for October 11, 2015

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