PrefBlog

Jason Zweig of the Wall Street Journal has some good advice for fixed income investors in a piece titled Investors: Do the Hard Thing, Don’t Do the Easy Thing:

The reach for yield is becoming a reckless lunge.

While high-quality bonds still have their place, too many investors are buying high-risk bonds instead.

Since June 30, according to TrimTabs Investment Research, a firm in Sausalito, Calif., that tracks how money moves in and out of the financial markets, investors have poured $1.2 billion into exchange-traded funds specializing in bonds from emerging-market countries. So far in July, investors have pumped another $2.8 billion into high-yield ETFs holding so-called junk bonds issued by below-investment-grade companies.

Put simply, one out of every 14 dollars invested in those two fund categories arrived in the past three weeks.
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The easy thing is to submit to your worst instincts and reach for riskier investments that pay higher income — for now.

What is hard is to be patient and ornery. As bonds yield less, save more. Remember that you can get higher yield only by buying longer-term or lower-quality bonds — which will also raise your risk. With interest payments so low, long-term bonds are particularly vulnerable to an unexpected rise in rates.

So now it’s official: it’s not what you know, it’s who you know:

Among currently employed workers, those who found their job through a referral from their network had an average weekly salary of $772.20, or roughly $40,000 per year. Those who did not find their job via a referral had an average weekly salary of $725.84, or nearly $38,000 per year. On average, salaries were 6 percent higher if workers found their job through their networks.

Further, their earnings are even more positively skewed. One way to interpret this is that network searchers have more “upside” risk: They can potentially draw a variety of wages, but there are more very high potential outcomes through the network, To quantify this, Kelley’s statistic is 0.6 for network-finders and 0.44 for others, meaning that 80 percent rather than 74 percent of the dispersion between 90th and 10th percentile is accounted for by the top half (from 90th percentile to 50th).

The distribution of wage offers should typically be different from the distribution of wages among employed workers. Not all offers are accepted, and workers at lower wages tend to make more over time through selective job mobility and pay increases on the job. Still, even among the distribution of wage offers, we see a premium associated with those who found jobs through their network. Workers who were searching while unemployed received offers through their networks that averaged 62 percent more than those found through direct contact. Workers searching while employed received network offers that were 12 percent higher, on average.

This is based on a working paper by Marcelo Arbex, Dennis O’Dea, and David Wiczer titled Network Search: Climbing the Job Ladder Faster:

We introduce an irregular network structure into a model of frictional, on-the-job search in which workers find jobs through their network connections or directly from firms. We show that jobs found through network search have wages that stochastically dominate those found through direct contact. Because we consider irregular networks, heterogeneity in the worker’s position within the network leads to heterogeneity in wage and employment dynamics: better connected workers climb the job ladder faster and do not fall off it as far. These workers also pass along higher quality referrals, which benefits their connections. Despite this rich heterogeneity from the network structure, the mean-field approach allows the problem of our workers to be formulated tractably and recursively. We then calibrate and study the wage and employment dynamics coming from our job ladder with network heterogeneity. This quantitative version of our mechanism is consistent with several features of empirical studies on networks and labor markets: jobs found through networks have higher wages and last longer.

The war on markets continued today with the arrest of Mark Johnson, HSBC’s global head of foreign exchange cash trading in London:

The two allegedly conspired to take advantage of inside information about an unidentified company’s plans to sell part of its stake in an Indian subsidiary, according to the complaint. The client was Cairn Energy Plc, which was selling the unit to Vedanta Resources Plc, according to people with knowledge of the transaction. HSBC was hired to trade about $3.5 billion in proceeds of the sale to pounds. Johnson and Scott began buying pounds in the days before the transaction, anticipating that they would cause the price of pounds to spike — a practice known as “ramping” — then execute the transaction, making the pounds they’d bought earlier more valuable, according to the complaint.

Scott and Johnson — his supervisor at the time — told the client the deal should take place at 3 p.m. “so there’s an element of surprise” to get a better rate, according to the complaint, which quoted from recorded phone calls and messages between the two and their client. There was less liquidity at the 3 p.m. fix than the one at 4p.m., making it easier to manipulate, though they told their client they were about the same.

They and other traders they directed ramped the price, sending the pound to its highest in two days at 2:56 p.m. London time. When Scott told Johnson the client was still going ahead with the full transaction despite the spiking price, Johnson said “Ohhhh, f***ing Christmas,” according to the complaint. In the end, HSBC and the men’s internal accounts reaped about $8 million from the front-running, according to Brooklyn U.S. Attorney Robert Capers.

Click for Big

Well, the main thing that sticks out in this story to me is the fact that whoever it was at Cairn Energy who negotiated this deal is a complete idiot. Converting $3.5-billion into pounds in one trade at one specific time? Didn’t it occur to anybody to think, gee, this is kind of a big trade? It also looks as if this idiot who somehow managed to be in charge of $3.5-billion has no idea whether the guys at HSBC are fiduciaries or counterparties – and the idiot had a responsibility to know that.

The second thing to jump out at me is the question of what the authorities suggest HSBC should have done. They were told to convert $3.5-billion at the 3pm fixing, so they did. As they are not as stupid as the moron at Cairn Energy, they laid off their end in pieces. Does anybody care to guess in the comments what the execution price of the trade would have been if the entire order had been placed electronically as a market order at 2:59:59?

The White House has published a study pooh-poohing the theory that student debt has begun to harm the economy:

The White House just released a big report on student debt that contains all the familiar horrors about for-profit schools, indebted dropouts and students defaulting on their loans. But it has an interesting conclusion: That growing stack of $1.3 trillion in student debt is helping, not hurting, the U.S. economy.

That conclusion is sure to rankle the many student advocates and special-interest groups—from real-estate agents to employers seeking new tax breaks for their young workers—that argue student debt is a big “drag” on the economy. (Hillary Clinton and Donald Trump have each decried the rise in student debt.) But the 77-page report from the White House Council of Economic Advisers backs up its claim with numerous charts and studies from economists and academics.

The report itself, titled INVESTING IN HIGHER EDUCATION:
BENEFITS, CHALLENGES, AND THE STATE OF STUDENT DEBT, rebuts my main concern:

The rise in student loan debt has created challenges for some borrowers with lower earnings, but has not been a major factor in the macroeconomy.

• • Despite its steady rise over the past decade, aggregate student loan debt remains small relative to aggregate income. In 2015, total student loan debt was 9 percent of aggregate income, up from 3 percent in 2003. By itself this is considerably smaller than the rise in mortgage debt prior to the crisis and it has also been accompanied by a reduction in other forms of consumer debt.
• • Additional student debt, as an investment in education, is associated with additional income, putting many households in a better position to buy homes or start businesses. By age 26, households with student debt are more likely to buy a house than those that did not attend college. By age 34, college attendees with and without student debt are equally likely to buy a home, and both much more likely than those without a college education. Research studies have found that conditional on a given education, higher student debt explains, at most, a small fraction of the decline in homeownership among younger households.
• • At the same time, the increase in defaults on student loans as well as the increase in high-loan balances for low earners can be real concerns at the individual level, potentially leading to compromised credit and reduced home buying for some individuals.

My problem with the paper is that it concentrates on proving that post-secondary education is still worth-while, even if it involves taking on debt, which isn’t quite the problem I have focussed on. Debt+Degree is better than nothing, sure, but Degree is better than Debt+Degree! And the paper does admit that yes, there is a measureable effect on home ownership rates:

Work by Mezza et al. (2016) tries to identify the causal relationship and finds a larger, negative estimate of student debt on homeownership.31 Using only the variation in student loan debt due to differences in home-state tuition, they estimate that a 10 percent increase in student loan debt leads to a 1 to 2 percentage point decline in homeownership rates for the borrower. Their estimated effect of student loan debt on homeownership is larger than the Cooper and Wang (2014) or Houle and Berger (2015) studies. It is important to note that all of these studies focus on younger households, so it is possible that rising student loans have delayed but not reduced lifetime homeownership. In addition, these studies hold constant the level of education such that they focus only on the impact of debt, not on the education that the debt helped to fund, thereby excluding the positive boost to homeownership from increased education-related earnings.

As discussed on May 31, 2016 there is at least some reason to believe that student debt has harder-to-measure effects than the simple home-ownership binary:

A 2013 report by the think tank Demos found that student debt has a negative effect on income, by making borrowers more risk-averse and discouraging them from moving to another city or taking gambles on new jobs or launching a new business.

This paper, by Robert Hiltonsmith, titled At What Cost? How Student Debt Reduces Lifetime Wealth, was not addressed by the White House researchers.

There is also the underlying problem with student debt, that the ready availability of loans has caused tuition to skyrocket and that this additional revenue for the universities has not led to any meaningful increase in the quality of their product, but merely to an increase in the quantity of their administrators and the amount of marketing frills they offer (such as improved accommodation, meals, football stadiums, etc.).

So, while I appreciate the intervention of the White House in the issue, I do not consider their pronouncement to be the final words on this matter.

So guess who’s financing your mortgage!

Canadian Imperial Bank of Commerce has become Canada’s first bank to benefit from Europe’s rush to debt with subzero yields.

CIBC sold €1.25-billion ($1.79-billion) worth of six-year covered bonds – with a yield of negative-0.009 per cent – on Monday. According to a person familiar with the transaction, investor demand was so strong that the value of orders roughly doubled the deal size.

Not only is CIBC the first Canadian bank to issue such debt at a negative rate, it is also the first non-European bank to do so. In March, Germany’s Berlin Hype was the first lender to borrow at negative rates, cashing in on a hunger for quality debt, coupled with Europe’s unique fixed-income markets.

At the start of this month, nearly $12-trillion (U.S.) worth of government debt carried negative yields. As CIBC’s latest foray into the market highlights, the phenomenon is now spreading to other types of bonds, as investors search for securities that pay at least a tiny yield – or cost less to own than sovereign bonds.

Update: Here is a link to a brief explanation of Covered Bonds

Wal-Mart is continuing its battle with Visa:

Wal-Mart Stores Inc. can no longer count Marlene Gosparini and her employer as regular customers in Thunder Bay after the world’s largest retailer stopped accepting Visa Inc. credit cards at its three stores in the Canadian city.
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Wal-Mart prepared its Thunder Bay customers for the change in June when it posted a statement on its website. There were signs in stores leading up to the shift, and on Monday store greeters, employees and managers approached customers as they walked in to remind them of the change. Some cashiers even offered customers a chance to sign up for a Wal-Mart Mastercard.
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Visa ran ads in Thunder Bay’s newspaper Monday offering cardholders a C$25 online gift card for making purchases of C$75 or more at Thunder Bay grocery stores.
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Wal-Mart’s Canada unit, which pays more than C$100 million to accept credit cards annually, called the fees Visa charges “unacceptably high” in a June 11 statement on its website.