Below Zero

Today's financial world is certainly strange.  The Fed Funds rate is nearly zero.  US Treasury bonds yield a little above zero.  Five-year German government bonds yield -0.07%. 

Now some conservative financial managers anticipate something similar – or worse – for future returns on US stocks and bonds.

The conservative asset management company GMO released its most recent forecast of anticipated future real returns for several different asset classes over a 7-year time horizon.  As of Jan 31, 2015, their 7-year forecast projects negative real returns for US stocks and bonds.  Even for emerging markets the estimated future returns are far below historical averages.

Of course, these are just estimates, which GMO accompanies by the usual caveats.  But they are not alone in taking a pessimistic view.  After several years of stock market gains and artificially low interest rates, it is not surprising that nearly every financial asset class in the world is overpriced.  There have been plenty of warnings from market observers.

Markets arrive at overpriced points like this in the normal course of events, every once in a while, but this time is hardly normal.  This time the situation is entirely artificial, the result of extreme fiscal and monetary policies intended to prop up the financial markets and the real economy.  After the 2008-2009 financial crisis, only extreme measures could stop the financial world from crashing and sending the world into a deep depression.  To many people who lost homes and jobs, it was a depression anyway.

The economy is not responding as well as wanted, and so the Fed has continued to levitate markets with QE, low interest rates, and other manipulations.

The crisis was a chain of failures caused by unreal expectations and extremes of leverage.  The Fed and regulators were supposed to prevent such extremes from recurring.  Instead, they have added fuel to the fire, and financial markets are more leveraged now than ever.

If something happens, the repercussions of a crisis could be greater than in 2008-09.

We don’t have to look far in today’s world to find escalating financial risks and potential triggers:  deflation, currency wars, soaring government debt-to-GDP ratios in the developed countries, failing economic growth.  It is just a matter of time.

I wrote about issues like this until two years ago and then figured “Why bother?  I’ve said it all before.”  But the problem is still here, and it’s getting worse.  I can’t foresee the future, but there are many reasons to believe that when the markets crack, it will not end well.

Candyland

Old favorites, the gumdrop trees.

International Human Rights Day

Yesterday, December 10, was International Human Rights Day, celebrating the 65^th anniversary of the Universal Declaration of Human Rights, signed in 1948 by the UN General Assembly.

Since that time, nearly all of the world’s developed nations have established social welfare programs ensuring that their citizens enjoy the fundamental necessities prescribed in Article 25 of the Declaration:

Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care …

But that is not the case in the United States.  If you are a low income person in America, good luck finding adequate food, clothing, housing, and medical care. 

Medical care?  The Affordable Care act places basic health insurance within the budgets of millions more Americans, but it is far from universal medical care.  Of course, right wing extremists in Congress are laboring hard to undermine and reverse even the ACA and take that coverage away.

Housing?  HUD’s latest report estimates that 1.48 million people used a homeless shelter during 2012, but about a third of homeless people were not in shelters.  At least 1.1 million American children and youth were homeless for part of the 2011-2012 school year.

Food?  Even with present funding levels, it’s impossible for many families on food stamps to stretch their food budgets to last over an entire month.

Now, Republicans in the House of Representatives have been working hard for major reductions in the budget of the Supplemental Nutritional Assistance Program (SNAP), as part of their negotiations over the farm bill.  About four million people would suffer if Republicans succeed in cutting their goal of $40 billion from the budget over the next decade. 

Four in five SNAP families have incomes below the poverty line, and two in five have incomes less than half that much.  There will be no way for these families to make up the difference.

Health and well-being have much improved as standards of living have advanced since the adoption of the Universal Declaration, but let’s not forget that millions still lack these basic human rights.

Nelson Mandela, 1918-2013

A “Free Market” of the Rich and for the Rich

A recent post by Robert Reich (here) reminds us of the myths and lies used by the extreme right wing to justify reinterpretation of the “free market” in favor of their own, narrow interests.

Extremist Lies about the “Free Market”

Dr. Reich says:  “One of the most deceptive ideas continuously sounded by the Right (and its fathomless think tanks and media outlets) is that the “free market” is natural and inevitable, existing outside and beyond government.”  So, the extreme right says, keep government out of business. 

According to the revisionist lies of the Republican elitists, any attempt by the people to use government get the economy to work for them is wrong-headed and doomed to failure.  As Dr. Reich says: “According to this logic, government shouldn’t intrude through minimum wages, high taxes on top earners, public spending to get people back to work, regulations on business, or anything else, because the “free market” knows best.”

The Truth about the “Free Market”

Markets do not exist in and of themselves.  Laws, customs, skills, and infrastructure are all needed for markets to operate.  In fact, it is government that creates the conditions for markets to operate.  Dr. Reich provided a few examples of the issues that market rules address:

1. What can be owned and traded (the genome? slaves? nuclear materials? babies? votes?);
2. On what terms (equal access to the internet? the right to organize unions? corporate monopolies? the length of patent protections? );
3. Under what conditions (poisonous drugs? unsafe foods? deceptive Ponzi schemes? uninsured derivatives? dangerous workplaces?)
4. What’s private and what’s public (police? roads? clean air and clean water? healthcare? good schools? parks and playgrounds?);
5. How to pay for what (taxes, user fees, individual pricing?).

We the People Created the Market

As Reich points out, all of these rules are human creations.

We the people elect the government, and the government creates the conditions for the markets to operate.  Our representatives should set rules that benefit the nation in a broad sense by benefitting all of us, not just the rich and powerful special interests. 

It is not a matter of more or less government control of the markets.  We already have laws governing these kinds of issues, often to the exclusive benefit of the rich special interests served by the extreme right.

Don’t Let the Extremists Set the Rules

The right wing extremist lie about “free markets” is one of the biggest tools they use to shape the rules and regulations to favor their interests.  The right wing interests will do anything and utter any kind of lie to prevent us from creating market conditions that benefit the people.

We know the extreme right wing Republican Party for what it is – the same party that opposed scientific thought, racial equality, the rights of women, and anything else that did not aggrandize the controlling interests.  The party that uses bigotry, lies, and hatred to deflect criticism and maintain its control.

“Make the Economy Work for Us”

Markets without rules devolve into monopolies and abuses.  Maybe we have forgotten what our ancestors suffered through not long ago:  Child workers maimed by industrial equipment, consumers poisoned by contaminated foods, industrial workers enslaved by industrialists’ thugs and company police.  We are heading back in that direction.

We the people created the market, and it exists only to sustain us and our posterity.  If we fight the extremist lies and cruel policies that undermine the economic liberty of the great mass of Americans, perhaps we can achieve what Reich proposes and “make the economy work for us” -- an economy that works for all of us, and not just for the few on the extreme right who already control the wealth.

No Bank Runs Allowed

You might suppose that zero interest rates, and their attendant distorting effects on the capital markets, would be enough financial repression to last a lifetime, but you might be wrong.  This past week, our benevolent Secretary of the Treasury, Timothy Geithner, came out in favor of more repressive policies, this time targeted at money market fund investors.

Reforming Money Market Funds

Government financial overseers have for some time been reviewing a proposal to make money market funds less vulnerable to the systemic risks that plague our world, and which might otherwise lead funds to "break the buck" with shareholders.  The stated objective is to limit runs on money market funds that might further destabilize the financial system during periods of financial panic.

Apparently, the Securities and Exchange Commission was not convinced that this proposal was the right way to achieve that end, and it declined to act.  Such caution was not in Secretary Geithner's playbook, so he went over the head of the SEC and this past week issued a letter to the Financial Stability Oversight Council urging action.

Geithner's letter said that, without this measure, “our financial system will remain vulnerable to runs and instability.”  Although stability is a very laudable goal, we know that the Secretary and his friends have tended to go overboard before, and so maybe we ought to examine this proposal before he gets his way

What Would Happen to Your Money

Among the proposed "reforms" are features that provide a floating price for a money market fund.  That would work by defining a fraction of each investor's balance as the "minimum balance at risk", which would absorb losses if the fund was liquidated.  Redemptions of the minimum balance at risk would be delayed by 30 days.  In the event of an imminent financial crisis, this would force investors to remain partially invested in the fund long enough "to share in any imminent portfolio losses or costs of their redemptions."  In other words, no bank runs allowed.

What Would Not Change

Of course, even today investors in money market funds are not immune to loss, and the new rules would not change this.  Even under present rules, another crisis could arise suddenly and "break the buck" before any money market shareholder could react by withdrawing funds.

On the other hand, people who observe the financial landscape and actively manage their investments might in some circumstances be forced by the new rules to take losses that they could otherwise avoid if the financial system visibly destabilizes over a period of weeks or days.  Of course, people always think that they can get out of the door before the rest of the crowd, and a 30 day redemption delay might or might not make a difference in individual outcomes.

This Benefits the Banks, Not You

It is easy to predict that risk-averse people will withdraw money from money market funds and move them to safer investments if this proposal is adopted.  An official acknowledgement of the risks to money market funds would likely change investor perceptions and might prompt many to move their money elsewhere.  Maybe this is what Geithner and his friends in the financial community want.

It is easy to see who will benefit.  Risk-averse people would move money into insured bank deposits, on which the banks pay very little interest.  In other words, the proposed new rules would provide the banks with very cheap new funds.  With about $2.7 trillion in money market funds, this could provide the banks with a huge amount of cheap new funds. 

Cheap, new funds are exactly what the banks need to improve their balance sheets and continue their recovery from the financial crash -- and continue raking in profits at the expense of American savers. 

Of course the banks want your money market fund.  When the next "Lehman moment" hits, do you think the American people will allow their elected representatives to vote more money for the banks again?   Maybe the banks will need your money market fund.

A Signal That All Is Not Well

This is not to say that all the money withdrawn from money market funds will go to the banks.  Maybe some will go into Treasury bills, and maybe some will look for other havens.  Jesse's Cafe Americain wrote:  "I think quite a bit will go into gold and silver as people sicken of the financial repression of the Banks and their friends". 

It makes sense.  Money market funds have long been seen as a safe investment.  If the government changes the rules on money market funds, it will be a signal to the American people that something is wrong.  It will become more evident to shareholders that the financial system is not yet healed, that systemic risk remains high, and that the government has been extending and pretending.  It may even become clear that nothing has been done to solve the basic problems of indebtedness and leverage that got us into this mess.  People look for ultimate havens in circumstances like that.

The Zero Hedge blog started to raise the alarm on the proposed "reform" of money market funds starting about two years ago, and they revisited the topic this past week when Geithner's letter appeared.  I have no idea if the rules will be adopted, but the appearance of Geithner's letter shows that official circles are still highly concerned.