Thursday, December 10, 2009



Normally, at this juncture of the electoral cycle, one could confidently expect a "giveaway" pre-budget report from the Chancellor of Exchequer. Not so yesterday from Alistair Darling, who has quite clearly "run out of our money", to quote MEP Daniel Hannan. But hey, look on the bright side: deficit reduction starts next year, as the public sector borrowing requirement is forecast to collapse to £176 billion from the current year £178 billion.

Although Mr. Darling spent most of his time waffling on about woolly job-training schemes and business advice bureaus, the centerpiece of his PBR was, of course, the attack on bankers' bonuses. Similar to the story reported by Robert Peston yesterday, the Chancellor announced a one-off supertax, payable by banks/building societies and affiliated companies, of 50% on all bonus payments above £25,000.

How significant are City bonus payments to the UK? Let's put it this way: the sharp-eyed reader should have little difficulty in spotting the seasonal pattern on the chart below.
The bulk of those new year spikes are indeed represented by bonuses from the City. Now admittedly, not all City bonuses were affected by Mr. Darling's measures: brokers and hedge funds, for example, fall out of the web, since they were not backstopped by the government.

Yet the attack on the financial bonus culture is one that highlights a real fragility of the UK economy and public finances. For the twelve months ended in September, the average weekly private sector income was £443, according to the ONS. For the public sector, that number is higher, at £449. If we were to strip bonuses out of the equation altogether, the disparity becomes even starker, as public sector basic salaries are, on average, 7.5% higher than their private sector equivalents. Moreover, observe how that disparity has widened sharply this year.
Now, it's true that public sector workers include valuable memebers of society like doctors and teachers. But it also includes armies of civil service jobsworths and talentless morons like Elmer Fudd Jonathan Ross, who's on several million quid a year. And what sacrifice are these legions of leeches being asked to make? Guaranteed pay rises of "just" 1% per year.

Anyhow, there are a number of questions which arise from yesterday's debacle. Among them include the following:

a) Are banks really going to pay this supertax on bonuses? It's hard to say. Darling waggled his finger and promised to extend the tax if banks try to avoid it, but c'mon....he'll be out on his ass come May. Strangely, however, the Treasury only forecast a revenue generation of £550 million from the supertax, which wouldn't cover the charge from the Goldman London bonus pool alone, let alone all the banks in the City. Now, that could mean that a) Darling expects most banks to slip through the cracks, perhaps by issuing stock through an approved scheme? b) the increased tax burden from bonus payments can be offset by tax losses carried forward, in which case the ultimate result of this scheme will be to significantly reduce the tax-loss "asset" carried on bank balance sheets, or c) Darling is a moron and is bad at math.

b) OK, let's assume my bank is going to pay the tax. What is the impact on my bonus if the bank wants to leave the cost to itself unchanged? Here's where it gets a bit tricky. Banks have always been able to offset bonus compensation costs against company tax (which is set at 28%), so the "true" cost of bonus payments has only been 72% of the face amount. That hasn't changed.

But they now are further liable for 50% of the difference between the bonus face amount and £25k, which changes the marginal cost to the insitution quite dramatically. The graphic below derives the equation to determine the bonus that a bank employee will get in the new regime that would equal the cost to his/her employer of a given bonus before yesterday.
Ouch indeed. Someone who was slated to receive a £100,000 bonus will now get £69,000. £300k will become £187k. And that massive £1 million bonus will shrink to £600k. And of course, you'll still have to pay 40% income tax on this reduced amount!

c) How does Alistair expect to jump-start the economy in the new year when he's just taken a huge chunk out of private-sector cash earnings? Your guess is as good as Macro Man's. Anecdotally, he knows that a lot of bank employees were counting on a cash injection to finance big-ticket purchases. One could reasonably conclude that without the injection, the purchase will not happen.

d) If the supertax was to encourage banks to act more like utilities (i.e., making loans for the public good rather than trying to make as much money as possible), why doesn't the Government regulate actual utilities? No idea. Electricite de France is Macro Man's electricity supplier. EDF is constrained in their home market from charging more than a statuatory limit for electricity. Sans limits in the UK, the periodic arrival of the electricity bill is so painful that he's tempted to hook up electrodes to his sensitive bits to take his mind off the pain. Indeed, he's dissuaded from doing so only by the knowledge that the act would increase the charges on the next bill. Rather than cutting the public's fuel bills with the swift stroke of a pen ("But Monsieur Sarko, we are simply adopting the Continental model as you've been asking!"), Mr. Darling instead chose to offer a £400 tax credit to replace old boilers.

e) If the supertax is to dissuade the gambling culture in banks, why did Darling cut the tax on actual gambling, namely bingo payouts? For that matter, why are lottery winnings and payoffs from the bookies tax-free? Oh, that's's not about actual policy, it's about Darling being a vote-scrounging cretin.

f) Will employees of Vauxhall and Ford fall under this scheme? After all, US automakers filed to become bank holding companies last year to get some of that sweet TARP lovin'. Macro Man doesn't know the answer to this, but wonders if there are some sweating auto execs out there.

g) Is this is the start of a new global land-grab on financial companies' earnings? Perhaps, perhaps not. Macro Man is comforted by two things. First, despite their best efforts to gerrymander their way into another term in office, Labour has been so execrable that the best they can hope for is a hung parliament. The current cast of clowns is on their way out. Second, it was only eighteen months ago that the Chancellor was publicly mulling a windfall tax on energy companies at the height of the oil bubble. How times change. Yesterday, he offered to credits to encourage the drilling of new fields. To quote the old aphorism, "this, too, shall pass"....eventually.

h) And if it doesn't? Back of the queue for flights to Geneva, mate.


Anonymous said...

Some things simply don't have an economic basis per se ,they are politically motivated.
It was obvious that the public sector was and is going to be expected to contribute to filling the public debt hole.And of course this is barely a start..1% cap in 2011 is I believe the tip of the iceberg for what is still to come once an election is out of the way.

Trouble is you simply cannot do the above and be seen to walk away from attacking banking remuneration. Forget economic logic and right and wrong arguments as they are irrlevant.You simply cannot do it because you could not get it past the mass of the public sector. Think 1926 strikes all over again. Better to be seen to slap bankers and show some precedent for a 'sahre the pain' approach to solving the public debt problem .Not that that is what will really happen ,avoidance measures should see to that,but it will appear to happen and that is probably enough for the purpose in hand.

Anonymous said...

Farcically, guaranteed bonuses are exempted from this tax. Bonus will be paid as usual (unless you're no good, in which case this is an excellent excuse to doughnut you). Shareholders will pay the cost in reduced profit.

Anonymous said...

"Shareholders will pay the cost in reduced profit." the same shareholders that got overdiluted by new issuacne of lloyds and rbs shares?

Trywalker said...

Probably did one of the best trades ever at a very early stage in my life/carer by moving to Hong Kong instead of London.

Anonymous said...

Just one point:
c) Taking a big chunk out of consumption by raising taxes is never good for the economy, but taking it from the people with the lowest propensity to consume is the best one can do in a bad situation.( the richest simply cannot consume all their income, but the poorest consume it all and then some).

As per the rest of the post there is only one question to ask: Which is the longest river in Africa?

VandalsStoleMyHandle said...

"I guess you think I'm kicking you, Bob. But it ain't so. What I'm doing is talking, you hear? I'm talking to all those villains down there in Kansas. I'm talking to all those villains in Missouri. And all those villains down there in Cheyenne. And what I'm saying is there ain't no whore's gold. And if there was, how they wouldn't want to come looking for it anyhow."


Bill Daggett: I don't deserve this… I was building a house.
William Munny: Deserve's got nothin' to do with it.

VandalsStoleMyHandle said...

And one more:

Strawberry Alice: You just kicked the shit out of an innocent man.
Little Bill Daggett: Innocent? Innocent of what?

In general, I'm not a fan of arbitrary ad-hoc measures, but I think Darling got it more or less right. The message to banks is clear: work with us, or we're going to make your lives difficult.

Charles said...

lots of questions, lots of answers :

a) you forget the d) option : Alistair expects bankers to come to their sense and postpone bonuses for a year (at least). Meanwhile, the postponed bonuses acts find a good use as Tier 1 for the banks during the double dip you and I know will happen.

c) well, that is why you are a bear deep at heart, isn't it ? Did you really think that you weren't a part of the sinking economy you write so skillfully about ?

d) Electricity is cheap and stable in France because it is generated with nukes built on an industrial scale. BTW, a big chunk of Swiss Power is by nukes too, you will like it.

e) Bookies don't go crying at the Central Bank when they lost their shirts because England has been beaten 10-0 by Faroe Islands.

f) why not indeed ? but you would be surprised how little money these industrial peons bring to themselves.

h) if it lasts, western Institutional money will be required to be managed from EU or US based money managers. You may be able to play from Geneva, but will have to manage less money and to swim against a current of withholding taxes.

But What do I Know? said...

Agreed on the irritation/anger over the disparity between public and private sector pay. Many of the public sector positions (I assume that it's the same in Britain as it is here in the good old USA) are for useless "work." Of course, these folks never take a pay cut or get laid off or have their pensions cut--that would be "unfair."

In a shrinking economy there is no fair, only what you can grab and keep.

Oregon Guy said...

I thought public executions would do more to instill caution in the financial sector, but if Darling thinks a 50% tax will do I guess I'll put the axe down now.

haruspex said...

it would be interesting to see the comparison in public vs private pay done using the median, not the average. The higher moment of the distributions (stdev, skewness, kurtosis) would also be quite interesting, as I I suspect the public sector could be fairly peaked around the average, with negligible tails, while private distribution might be a bit more barbell like, with heavy tails.

haruspex said...

to the gentleman above writing:

"Many of the public sector positions (I assume that it's the same in Britain as it is here in the good old USA) are for useless "work.""

define "useless" please... how many jobs on the private side are "useful"?
You probably refer to state bureaucrats. Well I have worked in large private corporations, and I found the bureacracy and incompetence there worse than the one displayed by HM civil servants.

Anyway, there is no point in debating usefulness of jobs, as that would require agreeing first on a set of values (else only farmers are useful... everybody else just piggybacks on them).

Anonymous said...

MM I think the tax applies to all financial institutions that are regulated (including hedge funds - if you choose to be regulated by the FSA in this case). The relevant information is on FT alphaville.rgds

Gary said...

First a note of housekeeping. This is Gary, the one that manages institutional money and spent way too much time debating inflation with leftback a few weeks ago. There are many people in the world named "Gary" (and for some of us it is an alias), but someone other than me has been making comments with that name the last few days. I want to make sure he gets credit for his comments yesterday, and I get "credits" for ONLY the comments I wrote. My last comments were about CDS being a derivative of dubious merit, bordering on casino chip.

The other fellow deserves credit for comments yesterday.

Second -- I did comment (a lot) about the issue of sovereign risk. Your analysis of public sector pay reflects what usually happens when registered voters take the time to look under the hood (boot in UK?) to see how most governments waste money arse over teakettle.

Public sector productivity is a disaster (that is the diplomatic phrasing). Here in the states, it takes (on average) 4 or 5 public sector employees to do the work of one private sector employee. Public workers "work" shorter hours, get more holidays, and get vastly better benefits than anyone in the private sector. Public employees get very lucrative pensions, even after most private sector companies have stopped offering pensions entirely.

While California is the first US state to buckle under the corpulence of public sector unions, it certainly won't be the last. New Jersey, Arizona, New York, and Florida are all in trouble. Dozens of other states (including Connecticut) are in really bad actuarial shape, even if they don't admit it yet.

As more voters realize these rather blatant disparities, it will become very difficult for elected officials to argue for ever higher taxes to support "risk free" government debt. Asking lower paid private sector workers to make sacrifices for higher paid "public servants" is a tough sell.

Public services (everything from street cleaning to teachers to fire/police service) have been quietly cut over the last decade, even though total headcount has not. I am sure some teachers in particular will argue that last point, but read carefully. "TOTAL" headcount has not been cut. Teacher headcount was cut (in some towns), but administrative headcount was increased to match, and the administration often makes more than teachers to boot. In many towns here in Connecticut, education administrative staff outnumber teachers by a sizable margin.

Lets not even talk about the wasted headcount at the US federal government -- some of us just ate breakfast.

This is why sovereign risk (and municipal risk here in the states) is hugely under appreciated.

Either G-7 governments undergo massive restructuring and downsizing (meaning public sector unions go the way of the UAW, steelworkers, textiles, etc) ...

Or else someone else has to take the hit (bond holders).

Historically, unions have cried poverty and labeled bond owners as "rich Rockefeller types". Long term, not sure that will work this time -- public sector employees are lazy and overpaid. But short term (1-5 years), municipal bonds are far from risk free

And medium term (3-10yrs), something has to give at the federal level too.

Anonymous said...

fed draining reserves with reverse repos, snb stops buying bonds (QE end) ... another prick to the liquidity bubble.

Anonymous said...

Well, N. Sarkozy would like Paris to become the financial hub of Europe. He does everything to destroy the city. He speaks a lot’s and has a lot’s of anti-capitalist ideas to curbs bonuses and special taxes. Brave G. Brown is stupid enough to get the ideas and implement them, destroying the last remaining vestige of the British power while the French president doesn’t apply his own ideas in his own country.
Brilliant. Do what I say, not what I do.
It will be hilarious to see the UK to adopt the Tobin tax and not France.
Is the end of the city?

Anonymous said...

Once London and New York "succeed" in pruning back the financial sector, both cities will be revealed as the public sector sinkholes that they are.

Charles Schumer (D-NY) wanted to tax banks till they bled ... then New York City Mayor Bloomberg pulled him aside and showed him NY city's and NY state's cashflows, and how dependent they are on Wall Street.

Suddenly, the discussions of taxing Wall Street back to the stone age went quiet.

In the end, government officials won't admit it -- but the real reason they bailed out banks was to protect government power

zanon said...

MM: I thought the pity party was over. If only the finance industry had applied this level of scrutiny to whether people with no income could afford $M houses.

Practically speaking, most of the tax will be avoided, and a handful of bankers may leave the UK. I'd be surprised if it reaches 4 digits.

As for the negative impact on consumption, that's easily dealt with by paying out whatever taxes are eventually taken in. If the deficit's the same, there's no consumption hit.

zanon said...

Gary: Let me give you a hint about what the sovereign risk of default is at the federal level in the US: it begins with z and ends with ero.

The Treasury's cheques don't bounce.

Macro Man said...

Zanon: where's the pity party? This doesn't affect me in the slightest. I merely wished to point out that lost in the chortling schadenfreude of the slumbering classes is the grim fact that the PBR doesn't actually do a single thing to address any of the country's ills. And it is telling that the government pays more than the private sector in the wonder this place is swiftly sliding into third-world oblivion.

haruspex, alas broader data are not available. I would imagine, however, that the public sector median income is even further above that of the private sector, given that the latter is skewed by financiers and footballers.

Not that there aren't plenty of public sector employees on grossly inflated wages: in addition to the BBC "talent" alluded to earlier, there are a number of local council chiefs that make more than the prime minister. I know that Gordon is pretty lousy, but...WTF?

Gary said...

The "real" (after tax and after true inflation) return on 5y to 30y US Treasuries held to maturity is guaranteed to be negative -- none other than the Treasury Secretary and the Fed Chairman have said so.

The President is busy trying to devalue the US dollar -- even if he puts a political spin on it by labeling it an increase in the Chinese Yuan. Increase in Yuan = decrease in dollar -- they are the same thing

Rule #1 of investing in the US: Don't fight the Fed. Rule #2: Don't fight the Fed.

The Fed has said real yields (after inflation, but before taxes) will be negative for some time to come.

I won't argue with that

I also don't want to argue semantics of whether to call this a "loss" instead of a technical default -- its the same thing

Anonymous said...

you assess the risk of us default at z..o, but please specify a time frame.

over the next two hundred years i would assess the risk of us default at approximately o.e percent; however i am only interested in roughly the next fifty to one hundred years as that is about as long as i or my grandkids will live (and while i could worry about four generations out, at some point i just have to resign myself to the notion that every great civilization eventually collapses of its own weight and this one is certainly no different.)

haruspex said...

I would agree: the public median would be much higher. A lot of people in private sector are working at or around the minimum wage, and as you say a lot of private income is taken away by a few financiers, footballers and mindumb celebs.

IMHO, the distribution of private sector pay distribution is an even bigger one than the bloatedness of the public sector, with long term consequences on the structure of the economy and society.

When I have a mom I'll jot down something on bankers' bashing

Fleeing Yank said...

Gary - Agree with you on almost everything you have said - the municipal situation in the U.S. is much direr than even the financials industry understands.

Never fight the fed - and they have made it fairly clear that there preferred way out of this crisis is by inflation. They are fighting a deflationary spiral with real estate losses and job/wage declines. The easiest way out of it is inflation to push homeowners LTVs back below 100.The USD is the victim of such a policy, but for the Fed's point of view as long as their cost of debt can stay low the USD doesn't matter to them. If anything it helps the Trade Balance gap. China and Japan own too many USD assets and Treasuries to let yields spike in their face and the UST market has been a massive beneficiary of the asset allocation shift underway in the U.S. from equities to fixed income products (with a stop in money market funds somewhere along the way)

The real issue is the Fed has to maintain the "appearance" that they will fight inflation to keep funding costs low. If they don't jawbone to keep treasury rates low, MBS rates go up, and $1.25tr in MBS purchases are now 10% underwater and home price take another punch in the gut and the defiationary spiral starts again in earnest.

Its a fine line to walk - the Fed wants underlying inflation to help support asset values in the U.S./fight the deflationary spiral, but can't risk higher funding costs, and meanwhile the lower USD threatens the rest of the Global recovery - specifically Japan and the Eurozone (Germany).

Steve said...

Gary I don't think bonds are guaranteed losers though at the moment they're not all that attractively priced.

The 10-yr is 3.60% in the US, and it was only a few months ago that BE inflation traded down to zero.

As I have mentioned before here, in Japan it took 8 years after the collapse of the Nikkei in 1990 for JGB yields to trade below 2%, but once they did, then never looked back. Despite the very real issue that debt is 200% of GDP JGB 10-yrs are 1.25%--not a bad return if you had bought them at 3.60%.

Given where stocks are, and given the accumulating green shoots, I'd like to see 10-yrs north of 4% but I think the market prices in a significant (though low) probability of deflation.

But What do I Know? said...


I don't disagree that incompetence and inefficiencies are found in plenty of private organizations as well--but these generally get squeezed out over time (often a very long time). Look at Eastman Kodak, General Motors, Ford, Lucent, etc. These companies were sclerotic and have paid the price for it--and the benefits and salaries at those places have suffered. There is no effective corresponding brake on public spending--wage and benefit "cutbacks" are most often simply reductions in the rate of increase. The politicians are very clever about spacing out the the timing and size of the tax increases so the creep goes largely unnoticed.

Of course, here in the US the pensions are "guaranteed" by the local taxpayers and are nowhere near funded on an actuarial basis--but since cash flow is still positive no one cares. As long as the train wreck is 10-20 years out nothing will happen.

Gary said...

Fleeing Yank -- I agree the Fed has a delicate balance to walk (talking hawkish while running inflation).

The problems with this idea are many:
(1) The Fed is unfortunately staffed by humans, with all the failings that implies. The probability of them keeping this balance-- given poor and latent data, and rather blunt policy tools-- is zero

(2) While the US consumer has been (historically) the global consumer of last resort... we are, as a group, out of money and out of credit. China's forex policy (buying Treasuries to peg the yuan) is based on a mercantile export-centric policy. It is doubtful US imports will stay flat over the next few years (because we have no money and no credit). The Chinese require substantial export growth (not flat line) to maintain "social harmony" as they put it...

At the margin, the Chinese have no reason to continue buying more Treasuries. They can't easily dump their current holdings, but they could exchange them for real assets over time (oil reserves or Taiwan, take your pick). Short term, they will just roll over short term Treasuries, knowing this will result in a funding crisis for Washington sooner or later (and then they take Taiwan as the price of rescue)

In the meantime, el-Presidente thinks he is going to run trillion plus deficits for the next 10yrs. No one is going to buy these certificates of confiscation except captive Fed banks, who are using borrowed Fed Funds to do it. That inflation won't show up in the official statistics for several years.

(3) Throughout all recorded history, a bigger public sector results in slower growth. The US government (federal + state + local) is now over 50% of GDP. That's a fancy way of saying the US government's revenue base will not be growing as fast as its liabilities ... there is nothing Fed policy can do about that

Bernanke is a man fighting the last war IMHO -- but even if Volcker or someone more capable was at the Fed ... much of the problems lie in fiscal policy and a nation that regularly spends way more than it earns

The Fed has no tools to balance those problems

The UK is history. Technically, the country already collapsed back in the 1970s... The IMF bought them a couple years, and then the oil in the North Sea bought them a few decades. But that time out period was squandered. Unless the UK finds another huge oil deposit (that doesn't already belong to someone else) ... it faces ruin

Taxing the deck chairs on the Titanic isn't going to change the outcome

Gary said...

Steve -- BE rates on TIPs are irrelevent, they don't tell you anything.

The Fed's own studies show BE rates do not predict inflation.

Nominal rates are set by political decrees at the Fed. CPI is also set by political decree -- when Congress directly or indirectly rejiggers the formula

The difference between two politically decreed numbers has no predictive value

And if you read my comment **carefully**, I said "true inflation" was higher. Not reported inflation. The cost of living (health care, education, etc) is rising faster than the rate on 30yr bonds never mind shorter term.

The "deflation" you think you are observing in financial assets isn't deflation at all. Its more properly called technical default.

Anonymous said...

No Gary I got that. Apart from health care and education I think most prices are in decline, and especially the cost of dwellings, however you want to measure it. And even education is slowing to a crawl, it will probably flatline for a few years, IMO.

Our Man in NYC said...

Inflation/Deflation: At the most basic level, surely, it will come down to whether the banks lend the money the FED is 'giving' them (through C&I loans, or to consumers). If they do, some growth and lots of inflation...

So far, given the contraction in credit (and we can argue whether it's demand/supply) they've gone the lend to Treasury, speculate on assets, and pay out bonuses route. That will have a far smaller inflationary impact (and again, we can debate whether that impact is large enough to offset the deflationary deleveraging/unemployment spiral).

Until I see some lending going on, I'm going to find it hard to be overly bullish (broadly speaking; there's still some interesting bottom-up stuff, for the day-job)

Crisis Management said...

This tax charade serves to obscure the more pertinent issue that the present Labour crew ought not to have saved many of these corrupt banks in the first place. Let them fend for themselves the Barclays way, hat in hand on the SWF circuit.

Much talk in the press casually linking UK debt problems to those of the EU. UK officials have the luxury of playing political chicanery whilst their counterparts in the EZ are embroiled in a considerably more serious situation.

Confusion reigns over Europe as ECB Nowotny states: "It's not the ECB's job to help defuse these situations."

Merkel offered her observation that "What happens in a member country influences all the others, particularly when you have a common currency," Hardly reassuring.

Gary said...

Home prices are a financial asset -- they detached from being a "pure" shelter price decades ago. Further, home prices are clearly reverting to a long term trend (from a bubble condition) -- that is not the same thing as deflation

Mortgage bond prices falling is a combination of reversion to historical mean and technical default. You can't have 100% LTV and home prices falling -- and call that anything other than default. No, I don't care what moronic sales pitches the sell side uses. Its not deflation.

If you look at a long term (50yr) chart of the S&P500, there is a very obvious channel to stock prices up until the late 1990s. Then there is the dot-com bubble -- its huge and its obvious (even if Greenspan **chose** not to see it. Again, we are seeing reversion to the historical mean, which is not the same thing as deflation.

Democrats and Republicans are up in arms about how to further screw up the US healthcare system -- but everyone agrees the cost escalation is crazy. That's inflation.

Education costs -- the average college tuition this year increased somewhere between 4.5% and 6%, depending on whom you ask and whether you look at private / public or overall colleges. Because California is bankrupt, they can no longer afford to subsidize the UC system -- on 9 November of this year the regents approved a 29% tuition increase. No that is not a typo -- 29% increase.

UPS and FedEx both increased shipping prices by 5.1% and 4.8% respectively (FedEx started a little higher, the new price structure is roughly equal). Warren Buffet recently sold his Treasury bonds and bought Burlington Northern Railroad -- he isn't buying into the sell side deflation con job

The list goes on and on. Cost of living is increasing 5-6%, as Main Street has known for some time. Until 2007, they made up the negative spread with home equity loans -- but that's over.

Wall Street can lie and whine about liquidity problems (which is really insolvency problems) and financial asset deflation (which is really default and reversion to historical means) ... but they aren't fooling anyone but themselves

Gary said...

OOPS!!! My mistake. California is raising tuition by 32%, not the 29% I mis-stated.

Here is the link:
Regent's raise Tuition 32 Percent

Sorry Wall Street -- inflation is rampant. Treasury bonds are trash

Our Man in NYC said...

Gary: If that was at me, agreed on financial asset prices (not equal to deflation) and financials liquidity (does equal insolvency)...and they're among the reason that I'm not a holder (net) of equities.

But they weren't what i was referring to. It was individuals/commercial businesses and debt reduction...

As for the sell-side; the ones I speak to are still peddling the FED creating massive inflation, Treasuries will default, buy stocks line

Anonymous said...

One of the best H&S from Brad DeLong.
Agree with the sentiment of public employment gravy train esp re ridiculous salaries of council admin, (altho still not a fan of ibanks and thought this tax was unavoidable post bailout as well as for keeping the electorate happy), Private Eye's Rotten Boroughs column does a sterling job of tracking the greed. But, is the public sector stepping into a gap? Just look at the ridiculous incidence of public sector employment (~50%) in the border territories oop north, there are no other jobs there.
It's clear to most people that cost of living has been increasing more than CPI for a while, but in the absence of reliable stats what to do? Surely the break when Main St can no longer keep up will lead to depression/deflation.
On the wobbly prospects for sovereign debt, if households or corporates step up their purchases problem solved in my view. Feels like the Japanese experience at the mom.
Long real assets/short paper ones.
Bit long winded, JL

leftback said...

"New York City Mayor Bloomberg pulled him aside and showed him NY city's and NY state's cashflows, and how dependent they are on Wall Street."

Agreed absolutely, this is the ONLY reason that WS bonuses are going to be allowed this year. Paterson looked at those numbers (in a manner of speaking, since he is blind) and didn't like what he "saw".

Gary, your posts have been absolutely excellent and I always read through entirely even if I don't always agree with your points and interpretation the information content is tremendous, thanks.

Gary and Our Man, the argument we have is in many ways semantic. Some people call falling asset prices deflation, some people call decreased credit deflation etc.., what the sell side is selling is raging inflation, and not all of the buy side is buying it. Besides as Macro Man pointed out we may well see falling home prices and rents for several more years alongside bouts of commodity-driven inflation stoked by QE adventures.

Now shall we talk about these auctions? Not great, although not yet disastrous - sooner or later they are going to have to persuade investors that we are NOT going to have DGDF and eternal printing. In order to do that, equities may have to be sold which means we may see a decrease in happy talk and backstop language.

Anyone think the curve has steepened enough for the time being?

Gary said...

Our Man NYC: No, my ridicule of Wall Street's "deflation con" was aimed more at Steve and Anon 4:58

Some sell side firms have switched gears (better late then never), but they still claim inflation is "coming" (not already here). And the absurd quoting of TIP B/E rates as indicators of anything (other than politics) continues

I am not sure what you mean with the business / individual lending?

It seems the prudent man (business or self) is looking to delever. Hence, I would expect to see a lot less borrowing going forward (which obviously means less lending too).

I also note that bank lending officers by and large are untrained. The few industries that I talk to and are still borrowing (energy in particular) say that banks don't understand their business at all. They make absurd information requests aimed at filling out a one-size-fits-all form, and don't bother to understand the client or his business.

Hence, many of these borrowers are turning to vendor financing and/or private placements. You won't see that lending showing up on bank balance sheets -- probably never again.

To use the extreme example -- Exxon is a AAA rated company (and deservedly so). If Insolvent Bank Corp goes and borrows at (ahem) single A rates, what is their lending spread to Exxon? And why wouldn't Exxon just bypass the financial intermediaries altogether?

Answer: Exxon has been doing this already, for years. Now, borrowers further down the food chain have joined them.

The banks are left to fight to the death for what can only be described as less desirable borrowers -- those whose ability to repay is doubtful. But because of politics, lending laws, etc -- they aren't allowed to charge a rate that reflects the added risk of their new clientele.

That these folks opt to borrow from the Treasury (through the Fed) and then lend it back to the Treasury (through T-bonds) is hardly a surprise.

The steep yield curve makes it a good play right now -- but the reality is they don't have any economically viable choice. Until home prices revert to historical mean, housing inventory gets "cleared" and existing mortgage loans are written down -- playing the Treasury curve is the only game in town for the banks

Their better (more profitable) customers have better (less costly) options.

Financial disintermediation started well before this credit mess

Steve said...

Gary what I meant about dwelling, however defined, is that that cost is declining. In NYC rent is over half of peoples' after-tax incomes if memory serves (mine certainly is), and that price is dropping like a rock. Houses are cheaper, and 30-yr mortgages are sitting at 5%--this is a huge decrease in price.

I am from CA, the university is having a crisis and has raised the price to be in line with most state institutions, it's still reasonable. That's not a great data point.

Gary said...

Steve -- I don't care what your personal home price is doing. California is a huge mess and you can't claim it is indicative of the country as a whole.

And even if you could make that claim -- we are talking a financial asset reverting to its historical mean. That many home squatters lived like the bubble was real means that for many this reversion to the mean will also result in default (technical or literal).

California's spendthrift policies have also led to a cost structure that destroys jobs -- which destroys people's ability to pay for housing.

None of that is deflation.

The Fed's efforts to monetize this bubble and prevent prices from reverting to their historical mean is massively inflationary.

That US Treasuries are priced below real inflation means a Treasury buyer is guaranteed to lose in real terms (and that is before taking into account taxes).

That the borrower (the Treasury) has a policy of not paying back the loans in real terms means the borrow intends to technically default (even if it is a partial default).

Gary said...

By the way MM: Just so I am not labeled a permanent bear / grouch...

Christmas came a little early this year (today actually). A pension fund that we part sub-manage came in and "told us" our management fee was going to go down next year. They also told us that the assumed return on the portfolio had been increased to 8% (from an already stupid 7%) and that they expected us to meet that goal, at minimum (and for the reduced fee).

Some of us who shall not be named had earlier lobbied for ejecting this client... whatever annual fee times 5-7 years (maybe less), minus the inevitable lawsuits when the bigger pension collapses, was always going to be a losing business venture.

But the client increased their "expected" returns and demanded a management fee reduction... and I didn't even have to re-argue the point. As of 31-December, no mas.

I share this business "failure" with the blog to point out that there are still a lot of skeletons in the pension closet, and they are only exacerbated by the Fed keeping rates well below what the market would charge. Propping up insolvent banks and monetizing a housing bubble has huge immediate and long term costs ... even if many people *chose* not to see them

Anonymous said...

let me share something with you>My wife a supremely qualified and educated theatres sister has already been delivering more for the last two years and will do so for less in the next few years.So ,you imbecile would you like to tell me what makes you so special? I could chop 80% of you arrogant pillocks out of the global financial system and we wouldn't even notice the ripple.Join the real world son.

leftback said...

Calm down, chaps...

That 4.52% yield on the 30y didn't last for long today, did it? Clearly return OF principal is still an issue...

Before Gary buries the US treasury market, we must recall that there are plenty of people who are long EM debt and US HY credit who may wind up Bringing It All Back Home before all is said and done. Gary is right in the longer run, but perhaps not in the short term.

Gary said...

Anon 7:10 My wife a supremely qualified and educated theatres sister has already been delivering more for the last two years and will do so for less in the next few years.

Your writing skills are horrible. I don't even know what this means.

I could chop 80% of you arrogant pillocks out of the global financial system and we wouldn't even notice the ripple

Chop away! I just said that I had been chopped from this foolish pension fund -- and I couldn't be happier! A huge unrealistic burden was lifted from my shoulders

Fed funds will dramatically increase, or else pension funds will have to assume much lower returns -- meaning people will need to work well past 65.

It used to be that way -- when Social Security created the illusion of retirement at 65, life expectancy was 67 (2yrs of retirement). Life expectancy now is 83, so retirement should be at 81?

For privacy reasons, I obviously rounded the client's before and after assumed returns -- but pretending a responsible fudiciary can get 7% returns (never mind 8%) in this environment is absurd.

If you feel a "theatres sister" (whatever that is) can consistently get that return, by all means put her in charge of your pension money

Steve said...

LB the "long run" in Japan is 11 years and counting.

We lost a lotta good men shorting JGBs in the '90s.

Gary said...

Steve -- it depends if you are short term trading or investing

Some people made money trading (shorting and buying JGBs) throughout Japan's lost 20yrs. But by and large, *trading* in these instruments dried up because you can't get to excited over 2-3bp moves.

Investors got decimated. It is so bad that Mrs Wantanabe opted to try her hand at forex trading and forex carry trades.

While it took an awful long time to question elders in a patriarch society -- eventually the LDP got shown the door

In the west, most people just shove gramps in an old folks home -- and visit irregularly. I doubt western voters will have the same nostalgia for their current politicians as Japan did.

Also, Japan had (and has) a lot of savings. The US and UK have a lot of debt. Hardly comparable situations.

leftback said...

True, Gary, if yields get as low as JGBs then trading in USTs would also dry up. But we are some way from that situation, as long as there is a substantial "risk-on" trade in credit here and in the EMs.

FWIW, I share your forebodings about JGBs and eventually US debt as well, but believe it is a slow moving train wreck and other things will crash and burn long before we get there.

Our Man in NYC said...
This comment has been removed by the author.
Our Man in NYC said...

Gary: Sorry for mistaking your ridicule...was reading far too briskly between calls.

FWIW; agrees with Gary on JGBs (and eventually US debt) and LB on timing :)

Gary said...

LB -- I just unloaded an absurd and unrealistic 7%/yr burden... And its a lot easier to outperform whatever liability index with a smaller portfolio. I have a smile like Bill Clinton in a whore house right now.

I could care less what the hell happens to bonds for the next couple weeks. Its Santa time

Gary said...

LB / Our Man ... sorry for the euphoria

I doubt the US gets down to JGB levels. Its not that it is impossible, but no one has explained how the baby boomers can retire on 0-1% bond yields. And there are a lot more baby boomers than there are Treasury traders.

Social Security and Medicare are already USD45 trillion (present value terms) in the hole. That's a lot of taxes / inflation just to pay for existing promises -- the math just doesn't work.

I think the probability of Obama (or whatever politician) getting on TV and asking Americans to work until they are 85 is pretty low. That's what it would take to make low yields like Japan work here.

Already, the 2006 law allows companies to make lump payments from pensions discounted at corporate bond rates, instead of the previous govt bond rates. That card has already been played

Unless I hear a dead man on TV announce the retirement age for baby boomers is 85 ... I don't see ZIRP working medium term in the US

As a matter of fact -- I see Bernanke having to confront this mismatch probably next year. Certainly it will be an issue for the next presidential election (entitlement programs become cash flow negative next year 2010) Should he upset the baby boom generation or a handful of bankers?

leftback said...

Yes, not as low as JGBs, but lower than many think. The critical variable is perception of risk. When risk assets can no longer be assumed to be universally backstopped, Treasuries will look attractive.

Gary, your euphoria is quite understandable. Of course, you're right, it's Santa time, and LB will drink to putting this year in the books, and it sounds as though Macro Man is eager to do so too.

der Tillman said...

Wow. I had a crazy day today and didn't get to reading the post until late...but fantastic comments today. Bravo!

Anon @ 7:10 - wtf! Why such bitterness?

Gary - we're all glad you didn't take the bait.

zanon said...

MM: Apologies! I detected a tone of self pity in your post. It must be projection. I also strenuously object to you claiming bankers are not public sector employees. I know what the private sector looks like, and banks is not it.

I also agree with your assertion that the UK is sliding into a third word oblivion. Any Englander from 1809 who was transported to the UK in 2009 would sob openly, and then probably kill himself, stiff upper lip be damned.

Anonymous: I will be more precise. The US has zero risk of Federal default for as long as the Govt maintains its ability to tax. Whether this will extend for another 200 years, I cannot say.

GARY: I'm shocked that we seem to agree on another thing. I too believe that low interest rates right now are doing more harm than good.

Anonymous said...

Mr Macro Man... There is only one problem with the post. Hedge funds and brokers might not escape it even if they are not backstopped by the govt. Proof? Check out the definition of bank as descibed by the FSMA act....

Macro Man said...


Anonymous said...

Hi Macroman,

I really like reading your blog. But one thing I really cannot agree with is c.)

As an economist I really gotta ask you: what kind of value exactly are investment bankers, hedge funds etc. creating in the first place (even in business terms) that has to be remunerated so insanely? And even the profit they make is often reached by illegal methods like front running, insider trading, fraud etc. So why not at least tax it?

Then about the "getting the brightest heads" argument: is a say 200.000 GBP or USD salary not enough to motivate oneself? And as Paul Krugman recently put it (and I mostly do not agree with him): it would probably be better if more of the bright heads went to sectors that really can advance an economy and society. Unfortunately a lot of those stupid bankers (sure there are exceptions to the rule) just do not understand that there is always more about a society than just markets and business. So if they don't get it on their own, they gotta be taught, one way or another.

And last about the consumption argument: I think we agree that propensity to consume declines with financial wealth. So, in order to get a more stable consumption behaviour it would be better to "distribute" income to people with lower income...

Best regards from "good old socialist Germany".


Anonymous said...

Here is a link by hmrc defining a bank : note that dealing in a regulated activity on your own account is also included.