EC Everything Is Broken

I was on a client call earlier this week with Steve Blumenthal. The gentleman is at that stage in life where he needs cash income and not risk. Steve commented, “The bond market is broken.” And indeed, the traditional fixed income bond market is broken, thanks to the Fed. We were able to suggest some alternatives (they are out there) that could help solve his problem.

But it got me thinking: "What else is broken?" And the more I thought, the more I realized that the data that we use every day, the very systems that we are forced to work with, are indeed in various stages of being broken.

There is a great scene in the fabulous movie The Princess Bride where the criminal “mastermind” Vizzini keeps uttering the word “inconceivable.” After the nth time, Inigo Montoya turns to him and says, “You keep using that word. I don’t think it means what you think it means.” Today we are going to look at data from the standpoint of Inigo Montoya. I don’t think that data means what you think it means. Indeed, much of the data in the way we use it is simply broken.

In a few weeks, I will do a letter on things that aren’t broken, which are in fact incredible. I am an optimist, but I’m also realistic. I am “long” on the human experiment. Government? Not so much. Our economic and financial systems are badly broken in multiple ways. Some of the cracks are enormous, maybe beyond anyone’s ability to repair. Step one is admitting they are broken.

Today I will describe several major breaks—some obvious, some not. I hope to help launch a conversation about fixing them. Let’s look at some broken things.

Broken Credit

People correctly describe compound interest as a kind of miracle, even the “Eighth Wonder of the World.” The miracle has another side, though. For you to receive the benefit, someone else must go into debt or take risk.

Debt isn’t necessarily bad. It can be wonderfully productive if it lets you acquire something (like education) that increases your income, or a durable asset like a home. It becomes potentially problematic when used for other purposes, as is often now the case.

Excess debt accumulates in part because the price of debt (interest rates) is increasingly artificial. Politically-appointed central bankers manipulate interest rates and credit terms in order to achieve desired admirable policy outcomes, like higher employment and economic growth. Elected officials create subsidy programs that encourage yet more borrowing. And while they can point to a link between low rates and their targets, they ignore or forget about some of the unintended consequences.

These well-intentioned efforts may help some people, but they have side effects. Borrowing costs are widely mispriced, bearing little connection to the actual risk of a given loan. This is unfair to both borrowers and lenders. They pay/receive too much or too little. It is the inevitable result when committees, instead of markets, set important prices.

Here’s an example. This chart shows the spread between 10-year Treasury yields and 30-year mortgage rates.

Source: Wolf Richter

Obviously, lenders take more risk on mortgages than they do when buying Treasury bonds. We would thus expect mortgage rates to be higher, and they are. But does that risk really swing so wildly? Should it double, or fall by half, in only a few years’ time? Of course not. But that’s what happened, and there’s no mystery why. Mortgage spreads collapsed in 2009 and 2020 because the Federal Reserve bought truckloads of mortgage-backed securities.

Economic fundamentals didn’t do this. A committee decided to encourage home purchases and did so by making it cheaper to finance those purchases. The predictable result is a housing boom. Or, in the current case, amplification of a boom that was already happening for demographic and other reasons.

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Let me mention something that’s changed but isn’t broken: the Mauldin Economics Strategic Investment Conference. This year’s online SIC—being held on five ...

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Moon Kil Woong 1 month ago Contributor's comment

Unemployment is best reflected in the percentage of people not working maybe minus those in retirement. I think everyone agrees the governments unemployment numbers are so manipulated they have no relevance in any logical system at figuring out the truth. They are purposefully designed to provide false answers.

Alexis Renault 1 month ago Member's comment

How so?

Moon Kil Woong 1 month ago Contributor's comment

They calculate people filing for unemployment which has been manipulated by trying to find reasons to cancel benefits and lower the time people may be on them. Also it doesn't fully deal with those who are underemployed or do not qualify for unemployment mostly due to the fact they can't find a job for over a year.