Landmark Links March 16th – Unexpected Outcomes


Lead Story….  Between a hectic stretch at work and an under-the-weather 3 year old, I didn’t have much time to blog this week.  However, I read a Wall Street Journal article by Greg Ip about the 10-year anniversary of the Bear Stearns bailout and found this section about increasing risk in the global financial system particularly interesting (emphasis mine):

Mr. Shin pointed out that bond markets are growing at the expense of banks in supplying credit, enabling business and government debt loads in many countries to surpass their precrisis peaks. Emerging markets have borrowed heavily in dollars, which leaves them vulnerable should the dollar’s value rise sharply. Before the crisis, 80% of investment-grade corporate debt world-wide yielded more than 4%; as of last October, less than 5% did, according to the International Monetary Fund.

Total U.S. debt, at around 250% of GDP, still stands at crisis-era peaks while debt levels in China have caught up and passed the U.S., according to the BIS. U.S. companies’ debts had reached 34% of assets by the end of 2016, the highest at least since 2000. Debt-servicing burdens haven’t risen commensurately thanks to low inflation and low rates, but they have begun climbing. More than $1 trillion a year still flows into emerging markets each year, according to the Institute of International Finance.

This tells us little about when or where a crisis will happen or what may trigger it. Crises surprise because they usually start with an assumption so sensible that everyone acts on it, planting the seeds of its own undoing: in 1982 that countries like Mexico don’t default; in 1997 that Asia’s fixed exchange rates wouldn’t break; in 2007 that housing prices never declined nationwide; and in 2011 that euro members wouldn’t default. James Bianco, who runs his own financial research firm in Chicago, speculates that the equivalent today might be, “We will never see higher inflation or higher growth.” If either in fact occurs, the low interest rates that have raised household stock and property wealth to an all-time high relative to disposable income won’t be sustainable.

Mr. Rogoff concurs: “It’s much harder to get a crisis when you can borrow for virtually nothing and keep rolling it over.” A 1.5 to 2 percentage point increase in real interest rates, which he isn’t forecasting, would be small by historical standards but could potentially make the debts of Italy or Portugal unsustainable.

Central banks know this, of course, which is one reason they are wary of raising interest rates too quickly—while nervous that if they raise them too slowly, the problem will get worse.

Economist Hyman Minsky came up with the “financial-instability hypothesis” which postulates that long stretches of prosperity sew the seeds of the next crisis.  IMO, that is what Ip is referring to above.  If an asset or financial instrument is perceived as being absolutely safe, investors and speculators will naturally take on more risk in order to own it.  This ultimately leads to abnormally high valuations, too much leverage and ever-increasing risk.  Eventually, values get pushed to such a high level that a tipping point is reached.  It made sense to borrowers and lenders to borrow aggressively to buy homes in the early 2000s.  Why not since homes only go up in value over time?  It was easy money until it wasn’t.

In recent years, I’ve frequently heard that one of the biggest macro risks in the market was that the Federal Reserve didn’t have enough “fire power” to provide stimulus in the next recession since rates were already so low.  However, of late I’ve been noticing a different theme among several investors and writers that I have great deal of respect for.  That theme is that the true market risk is not the Fed’s inability to cut rates but rather it’s inability to raise them should inflation begin to take hold.  US debt to GDP was in the low 30% range in the early 80s when Fed Chair Paul Volker hiked short term rates close to 20% in order to stomp out raging inflation.  In contrast, today’s debt to GDP ratio is approximately 104%.  As a result, should inflation flare up again, the Fed would not be able to respond as aggressively since it would push government borrowing costs through the proverbial roof.  Ironically, that very lack of an aggressive response could be the catalyst that ultimately leads to even more severe inflation and soaring long term rates.  I’m not saying that this is going to happen, nor am I saying that it is anywhere close to the most likely outcome.  My point is that it’s simply prudent to ask yourself what the other side of the argument looks like when a financial assumption is so pervasive and widely accepted that it becomes conventional wisdom.


Graying: The elderly will outnumber children for the first time in US history in 2035. So basically, the entire United States is becoming Florida other than the weird crime part..

Missing Middle: Despite California’s immense wealth, its middle class is in decline because it turns out that none of them can actually afford to live here.  See Also: California is losing residents via domestic migration.

Resurgence: So called “bond vigilantes” are poised to return to the market as expansionary fiscal policy and resurgent inflation expectations buoy bond bears.  But See: The latest economic data still show soft inflation despite economist expectations and a tight labor market.


Help Wanted: Construction jobs are booming and postings on are at a six-year high for this time of year.  However, job seeker interest in the sector is declining.  See Also: The labor pool is shrinking and it could be decades before it comes back.

Mixed Use: The mall of the future may not have any stores as owners look to bring in a mix of tenants that drive traffic such as office users to replace dormant department stores.


No Vacancy: There are almost no empty houses in California as vacancy hits a 13-year low.

Twisted Logic: California State Senator Scott Weiner’s SB 827 transit density bill has put left-wing anti-development activists in a difficult positionSee Also: If you really want affordable housing, follow Tokyo’s example just build more of it.


Sleight of Hand: Private equity shops are increasingly dragging their feet on bridge loan acquisition takeouts in order to artificially boost IRR’s, making it difficult to find an “apples to apples” return comparison in the industry.

Boom and Bust: How Toys R Us grew from a small children’s furniture store into a retail empire only to miss the boat on e-commerce and eventually crumble.

Broken Clocks: Predicting the demise of Silicon Valley has become a virtual cottage industry but the actual data suggests that the Bay Area economy is doing just fine in spite of the astronomical cost of living.

Chart of the Day.

Shocking(end sarcasm her) News: California impact fees are higher than the balls on a giraffe.

Source: Terner Center at Berkeley


Side Effects: A startup is pitching a mind-uploading service that preserves your entire brain in a computer hard drive with the minor side effect of being 100% fatal.  This is why I never buy first generation technology.

Take the Edge Off: A bride who was driving to her wedding, in her wedding dress was arrested for driving under the influence.  I wonder if the wedding album will include her mug shot.  (h/t Adam Werblow)

Darwin Award Update: A Minnesota woman who shot and killed her boyfriend in a Youtube stunt gone wrong was sentenced to 6-months in prison.  The following is a perfect summary of why I have no hope for the future:

The stunt that killed him June 26 involved Perez shooting a powerful handgun at a thick, hardcover book that he held to his chest in the mistaken belief that it would be enough to stop the .50-caliber bullet.

Apparently, you get a reduced sentence if the video goes viral.

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