E-piphany

Fortunately, by the time our power went out last night I had already sent my commentary – uncharacteristically early, and uncharacteristically lucky. It was only out for 13 hours or so, but plenty long enough for me to reflect on the Atlas-Shrugged-ian nature of scattered blackouts during hot, but certainly not unprecedented temperatures…and towards the end of the day, when air conditioners were presumably laboring less. For years upon years, this country hasn’t invested in significant upgrades of either power production (e.g., nuclear) or the grid itself, and so moderately-hot (but eminently foreseeable) weather simply cannot be accommodated. It isn’t a new phenomenon, of course. NIMBY has a good running start.

If there is a weakness in our version of Democracy it surely is that legislators are not accountable in any way for the long-term. Therefore, to the extent that we have legislators possessed of noble intentions and who serve mainly for love of country, we get good long-term law; however, the short election cycle means that elected officials are subject to a certain short-termism since it is on that basis to which they are held accountable. The result tends to be better short-term results traded for worse long-term results, and these are rolled forward from one Congress to the next and even one generation to the next until they can no longer be, whereupon the long term and the short term converge in a blow-up.

Sound familiar? With all of the ink spilled about the failure to align Wall Street compensation with the long-term welfare of the firms and the system, very few people wonder about the rotten incentives that legislators have. Sure, we’re all getting ready to throw the bums out, but if it happens in November it certainly will be a rarity, and arguably due almost as much to the failure to show short-term results as to the miserable long-term decisions they have made (to really get a wave of anger, I suppose you really have to get that convergence where you exercise both the voters focused on the short term and also the voters focused on the long term).

Congresspeople, angry at the damage wrought by bad incentives on Wall Street, have proposed caps on compensation, extremely long vesting periods for incentive compensation, and various forms of “claw backs” built into compensation. Some have even sought to make such structures the law. I think that this makes just as much sense for Congress. Total compensation for Congress, the overwhelming majority of which is in the perquisites of office, should be capped at a very low level, Congressional pensions should be tied to the level of the debt relative to GDP over the long term, and if the country runs a particularly large deficit at any point then former Congresspeople should be forced to return some of the pay they had previously received.

Now, I hope we all recognize that this is somewhat crazy. If we do this, then the quality of people willing to serve in Congress will fall even further. It isn’t fair that a retired Congressperson’s pension should be tied to the government’s fiscal position, which may have something to do with decisions that Congressperson made in office but also has a lot to do with whatever idiocy the current Congress is up to. And pulling back money that has already been paid has all sorts of problems.

Then why is it okay to do that to Wall Street? Or at the place where you work?

We all recognize these problems, but the alternatives all suck. The folks who put together our system of government recognized the problems (although they also assumed that mostly patriotic, noble-intentioned people would make the sacrifice to hold office), but that’s why we get to vote these people out. The Framers also assumed we would be paying attention to our long-term interests as well as our short-term interests. In other words, they assumed that there would be adequate surveillance, and that the system would survive the rare occasions when the surveillance failed.

So far, they have been correct, but lately it has been somewhat touch-and-go. There’s nothing wrong with the system of surveillance; the problem is in the regulators…that is, we voters. I would argue that the analogous condition holds for Wall Street. It isn’t that there isn’t enough regulation, it is that the regulators (led by the Fed) were doing a rotten job.

Enough of soliloquy for today. I am apparently tired and cranky.

Initial Claims produced a rare positive surprise for economists; net of revisions to last week’s figure, Claims was 3k lower than expected. Now the bad news; as pointed out by one or two economists, this year GM decided not to have a summer shut-down[1] and since the seasonal adjustments incorporate some effect of a shutdown over the next few weeks, ‘Claims are likely to be a smidge lower than they would otherwise be. The indicator is normally quite volatile in these few weeks anyhow, and the story remains the same: Initial Claims are still running at about 460k.

Of more note is the fact that the 10y TIPS auction bid was not only strong enough, it was plain strong. The auction stopped 3bps through the 1pm trading level, with a 2.88:1 bid-to-cover ratio despite the size ($12bln) being at the high end of Street estimates. We all see core inflation sliding (although ex-housing it is not)…so then why is institutional money so hungry for inflation-linked bonds? Yep, like you and me they can see the writing on the wall.

Equity traders cannot yet see the writing on the wall, but then for the most part they can’t read anyway (which helps explain the popularity of CNBC, by the way). After rallying more than 3% yesterday, stocks rallied another 1% today. The equity market now has its first three-day rally since April, and all it took was a 13% decline from the highs to make it possible! (Another 13% lower and you can have another 3-day rally). Investors are very optimistic about the earnings reports, seemingly because of the dearth of warnings, but I would be attentive to the guidance. It will likely be weaker than analysts are expecting. September 10y note futures fell 9/32nds, with the 10y benchmark yield up to 3.02%.

No data is due tomorrow, and it is likely to be a comparatively lazy summer Friday trading session.

One final note. Consumer Credit was just released, and fell yet again. The decline is mostly in revolving credit, and Chris Low from FTN Financial points out that this is probably related to changes in credit card regulation enacted late last year, which (by increasing risks for lenders) encouraged credit card firms to limit credit for riskier borrowers. The effect can be seen not only in the decline in revolving credit (which certainly cannot be a bad thing), but also in the decline in credit card delinquencies as the bad credits are squeezed out (this too, certainly cannot be a bad thing). In the chart below (source: Bloomberg), I have both credit card delinquencies and prime fixed-rate mortgage loan delinquencies. The point I want to make is that we shouldn’t be overly enthusiastic that the declining credit card delinquencies indicates personal balance-sheet improvement. It rather seems to indicate lender balance-sheet improvement as the result of tighter loan standards. Funny, that.

Declining credit-card delinquency rates are probably not indicative of improving personal credit

Footnote:

[1] Shocking! GM is owned by the government, and coincidentally is deciding that with unit car sales down about 25% from 2007-2008 levels, it is profit-maximizing to maintain full production!