Archive for September, 2007

• Chart of the Day
  Eddy Elfenbein, September 19th, 2007 at 7:37 am

  Leucadia National Corporation (LUK) compared with the S&P 500:
  

• 50 Points!
  Eddy Elfenbein, September 18th, 2007 at 2:16 pm

  Wow!!

  The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.
  Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.
  Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
  Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
  Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric Rosengren; and Kevin M. Warsh.
  In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 5-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City, and San Francisco.

• The Importance of Interest Rates
  Eddy Elfenbein, September 18th, 2007 at 1:24 pm

  If you’re new to investing or if you’re simply curious as to why us bloggers jabber on incessantly about the Federal Reserve and interest rates, it’s because it’s hard to overemphasize the importance of interest rates on equity valuations.

  Understanding this fact is one of the most important keys to investing. Simply put, interest rates call the shots for the stock market. Not only do lower rates make it cheaper to rent someone else’ money, but it also provide stiffer competition for stock prices so shares tend to adjust higher. When rates rise, the opposite happens.

  I’ll give you an example. I looked at all the data going back to 1962. I separated out each day that short-term T-bill rates fell. I then squished all those days together and found that combined, the S&P 500 rose over 2,000%. On days when rates rose—a nearly identical time frame—the S&P lost nearly 60%.

  As impressive as that it, for long-term rates, the effect is even more dramatic. On days when the 10-year T-bond yield fell, the S&P soared 90,000%. Wow! On days when the yield climbed, the S&P 500 dropped nearly 99%. If we try to annualize that, assuming 253 trading days year, that means the S&P gains 42.3% a year when long-term rates fall and it loses 20.4% when long-term rates rise.

  We can put those two variables together and see how the stock market reacts to the spread between short-term and long-term rates. Not surprisingly, stocks like a positive yield curve (when short rates are less than long). When the yield curve is positive (about 87% of the time), the S&P 500 gained 2,500%. When the yield curve is negative, stocks are down about 25%.

  Here’s the kicker: All of the S&P 500’s price gains have come when the yield curve is positive by 67 or more basis points. Anything less than that, stocks have flat. Zippo.

  One more thing. The current spread is about 45 basis points.

• The New York Times Hits a 10-Year Low
  Eddy Elfenbein, September 18th, 2007 at 10:03 am

  

• Greenspan’s Genius
  Eddy Elfenbein, September 18th, 2007 at 9:29 am

  Elizabeth Spiers looks at the Maestro:

  Americans have a long history of confusing inscrutability with genius. The less you say, the conventional wisdom goes, the smarter people will think you are. Alan Greenspan, the most powerful Fed chairman in history, built his storied career on this simple, if shaky, premise. His memoir, The Age of Turbulence, will be published this month, and it will be interesting to see how he stretches this rhetorical formula across 640 pages. Greenspan’s particular style has always been to offer a short restating of the facts that are obvious to most economic observers, peppered with a few original insights that can be interpreted as black, white, or a blackish-whitish shade of gray, depending on who’s listening. In Greenspanish, two and two may equal four. But it may also equal two discrete sets of two that shall never become four. And that assumes we all agree on how four should be defined. (If you find that analogy impenetrable, just make like a Greenspan acolyte and assume that it’s brilliant.)

• Economic Myths
  Eddy Elfenbein, September 17th, 2007 at 12:21 pm

  This is a good time to repost this. In December, Nobel Prizer Edward Prescott listed five economic myths in the Wall Street Journal. Myth #1 is that monetary policy causes booms and busts:

  One of the mysteries of the 1990s is how to explain the economic boom when the increase in capital investments — as measured by the national accounts — grew at a subdued pace. The numbers simply don’t add up. However, it turns out that something special happened in the 1990s, and it wasn’t monetary policy. In a recent paper, Minneapolis Fed senior economist Ellen McGrattan and I show that intangible capital investment — including R&D, developing new markets, building new business organizations and clientele — was above normal by 4% of GDP in the late 1990s.

  This difference is key to understanding growth rates in the 1990s: Output, correctly measured, increased 8% relative to trend between 1991 and 1999, which is much bigger than the U.S. national accounts number of 4%. Associated with this boom in unmeasured investment is the huge amount of unmeasured savings that showed up in the wealth statistics as capital gains. This was the people’s boom, the risk-takers’ boom. We should hang gold medals around these entrepreneurs’ necks. So indeed, it does seem that Mr. Greenspan was lucky in that a boom happened under his watch; but we can at least say that he did a pretty good job of keeping inflation in check. Here’s hoping for the same performance from our current chairman.

  What about busts? Let’s begin with the assumption that tight monetary policy caused the recession of 1978-1982. This myth is so firmly entrenched that I could have called this downturn the “Volcker recession” and readers would have understood my reference. To accept the myth, you have to accept a consistent relationship between monetary policy and economic activity — and as we’ve just seen, this relationship is simply not evident in the data.

  Between 1975 and 1980, the inflation-corrected federal funds rate was low; at the same time, output trended upward until late 1978. So far, things look somewhat promising for the mythmakers. But looking closer at the data we see that output began its downward trend in late 1979 while monetary policy was still easy through most of 1980. Also, output continued its decline through 1982, when it began to climb at a time when monetary policy remained tight.

  These facts do not square with conventional wisdom. Our obsession with monetary policy in the conduct of the real economy is misplaced.

  One caveat: I am not saying that there are no real costs to inflation — there certainly are. And if we get too much inflation we can exact high costs on an economy (witness Argentina as an example). However, I am talking here of the vast majority of industrialized countries who live in a low-inflation regime and who are in no danger of slipping into hyperinflation. It is simply impossible to make a grave mistake when we’re talking about movements of 25 basis points.

• AOL Is Moving to New York
  Eddy Elfenbein, September 17th, 2007 at 10:34 am

  I was always amused that AOL referred to its headquarters as being in “Dulles, Virginia.” Before it got that name, I tended to think of it as “that area way out by the airport.”
  Well, no more. Start spreading the news: AOL is packing its bags and heading to NYC:

  AOL is moving its corporate headquarters from Dulles to New York, the company announced today, ending a saga that helped cement Washington’s identity as a technology center but also gave rise to corporate scandal and ill-fated dealmaking.
  The company employs 4,000 people in Northern Virginia, and company officials said most will remain here. Senior executives, however, will be transferred to the company’s new headquarters at 770 Broadway in Manhattan.
  The company, which abandoned its fee-for-service model as subscriptions declined and internet access was taken over by cable and telephone companies, said it is making the move to be closer to the center of the advertising industry that is now crucial to its survival.

• Northern Rock
  Eddy Elfenbein, September 17th, 2007 at 10:28 am

  For the past few days, depositors in Britain’s Northern Rock have lined up to withdraw their money. Now the government says it will guarantee all deposits.
  Here’s how the stock has done:
  

• Greenspan Unplugged
  Eddy Elfenbein, September 17th, 2007 at 9:31 am

  Alan Greenspan is speaking this week at GW. I may go to see him, but I’m really not that interested. A few years ago, I would have jumped at the chance. Nowadays, I feel he’s just trying to defend his record, which is an increasingly difficult job.
  One of the aspects I didn’t like of his tenure was how he made his views known on subjects not related to monetary policy. As I’ve said many times before, the Federal Reserve is far less important than most people realize. I think the fact that it’s so secretive helps keep the illusion alive.
  Last night I saw Greenspan on 60 Minutes describe how he purposely gave incomprehensible answers to Congress. He worked hard at doing so. He and Lesley Stahl were giggling as if it were the cutest thing. It’s not.
  Today’s WSJ has more from Greenspan:

  Mr. Greenspan was himself a behind-the-scenes advocate of overthrowing former Iraqi leader Saddam Hussein. He says he felt “getting Saddam out of there was very important,” not because of weapons of mass destruction, but because he was convinced the Iraqi dictator wanted to control the Strait of Hormuz, through which a sizable portion of the world’s oil passes. That would enable him to threaten the U.S. and its allies. He said he conveyed that view to both Mr. Cheney and then-Defense Secretary Donald Rumsfeld, another friend from the Ford administration, but doubts that played a part in the Bush administration’s decision to invade Iraq.
  He recalls one administration official telling him such an argument couldn’t fly politically, which Mr. Greenspan assumed to mean because of Mr. Bush’s and Mr. Cheney’s background in the oil industry. Yesterday, Defense Secretary Robert Gates, appearing on ABC’s “This Week,” rejected the assertion in Mr. Greenspan’s book that the Iraq war “is largely about oil.” Mr. Gates said, “it’s about stability in the Gulf. It’s about rogue regimes trying to develop weapons of mass destruction.”

• Barney Frank on the Subprime Crisis
  Eddy Elfenbein, September 14th, 2007 at 12:25 pm

  From the Boston Globe:

  Well-functioning financial markets depend on transparency and confidence that institutions are playing by clearly defined rules. Both were in short supply in the months leading up to the August meltdown and remain so today. Large pools of unregulated capital, often highly leveraged, especially in hedge and private equity funds remain opaque and have been joined by massive sovereign investment funds to transform the financial landscape in ways that are out of reach of regulators here at home and in other wealthy countries. We lack the information that we need to ensure safety and soundness as well as the confidence that comes from the requirements mandating governance and reporting standards that apply to publicly traded companies.
  To an important extent these new pools of capital are structured in a fashion that allows them to avoid the scrutiny that is required of firms and financial institutions in the regulated sectors. We should not be surprised. It is a fact of life that investors and firms will seek to innovate their way around whatever regulatory strictures apply, whether they deal with health and safety, labor protections, or reporting obligations. This tendency has been exacerbated by a 30-year attack on the very notion of a regulatory role for governments and loud professions that the market not only knows best, but knows everything.
  Our job is to understand the changes in the financial marketplace and consider what we must do to ensure that our regulatory system is able to keep up with those changes. Innovation is as important in financial markets as it is in product markets, but it would be foolish to act as if regulatory structures, designed for a different world, do not have to be as nimble and innovative as those they regulate.