Bob Carlson

Politicians float a number of plans to solve the problem of too many homeowners being underwater, when the balances on their mortgages exceed the values of their homes. Being underwater with little hope of rising prices gives homeowners an incentive to default on their mortgages. That depresses home prices further. But simply writing down mortgages to the market value of homes creates a moral hazard and inequity. Why act responsibly when lenders will write down the loan after you make a bad purchase? Why should those who aren’t underwater but still saw declines in their home values not get some kind of a break?

In the past I’ve highlighted solutions from others that involve safeguards, hurdles, and equity kickers for lenders so that homeowners are encouraged to stay in their homes and pay their mortgages but the moral hazards are reduced. Here’s a summary of three keys to a successful  mortgage restructuring program.

If borrowers have a stake in the deal, that might keep some from trying to score a reduction. Under what’s commonly called a “shared equity” plan, underwater borrowers have their principals reduced to their property’s current value. In exchange, if the price of the property rises in the future, the lender would have a claim on a portion of the increase.

Using an example from economist Bill Wheaton at M.I.T., here’s how the plan could work: Say a borrower bought his house for $100,000 a few years ago. But then the price of the home has fallen by 40% to $60,000. Rather than risk foreclosure, the lender could lower his mortgage’s principal to the home’s current value. In turn, the lender would have a 50% claim if the home’s value rises in the future – capped at $40,000. So years from now when the owner sells the home for – say, $90, 000, the lender would collect $15,000 of the sales proceeds.

China’s become very interesting lately. I reported recently on an old-style political purge of politician Bo Xilai. There’s been a lot of confusion over what happened and why. It’s an important question, because it could mean a change in direction for China. Will it continue to open its economy and become part of the global economy. Or will it revert back to a traditional Chinese communist closed-system? Other scenarios also are possible. Because of its influence on the global economy and ownership of treasury bonds, what happens in China affects all of us.

For some insight, and a very interesting read, I recommend this item from the Foreign Affairs web site. As with all foreign affairs writing, it offers a particular point of view. I don’t know how accurate it is or to what extent the analysis is affected by the writer’s preferences. If it’s accurate, it’s good news for the rest of us in the global markets. Even if it’s not accurate, it’s an interesting story of how rivalries between two youths of Mao’s time still play out today as the men are past middle age.

Indirectly, but unmistakably, Wen defined Bo as man who wanted to repudiate China’s decades-long effort to reform its economy, open to the world, and allow its citizens to experience modernity. He framed the struggle over Bo’s legacy as a choice between urgent political reforms and “such historical tragedies as the Cultural Revolution,” culminating a 30-year battle for two radically different versions of China, of which Bo Xilai and Wen Jiabao are the ideological heirs. In Wen’s world, bringing down Bo is the first step in a battle between China’s Maoist past and a more democratic future as personified by his beloved mentor, 1980s Communist Party chief Hu Yaobang. His words blew open the facade of party unity that had held since the massacres of Tiananmen Square.

Years ago in an episode of M*A*S*H* Col. Winchester said to the other doctors, “I do one thing. I do it very well. Then, I move on.” Today, the emphasize is on multi-tasking and juggling many different tasks. If you participate in that trend, that’s probably why you’re also feeling like you’re not getting as much done and are falling behind. A post in the Harvard Business Review makes the case that people feel burned out and overwhelmed because they try to do too much and don’t work efficiently. It argues that multi-tasking and doing too many things makes you less productive, not more, in addition to feeling run down. The article offers suggested strategies for both individuals and businesses to improve their productivity and streamline their work habits.

The biggest cost — assuming you don’t crash — is to your productivity. In part, that’s a simple consequence of splitting your attention, so that you’re partially engaged in multiple activities but rarely fully engaged in any one. In part, it’s because when you switch away from a primary task to do something else, you’re increasing the time it takes to finish that task by an average of 25 per cent.

But most insidiously, it’s because if you’re always doing something, you’re relentlessly burning down your available reservoir of energy over the course of every day, so you have less available with every passing hour.

I know this from my own experience. I get two to three times as much writing accomplished when I focus without interruption for a designated period of time and then take a real break, away from my desk. The best way for an organization to fuel higher productivity and more innovative thinking is to strongly encourage finite periods of absorbed focus, as well as shorter periods of real renewal.

There’s an ongoing debate in the finance community about the best portfolio for retirees whose savings aren’t clearly enough to sustain their spending indefinitely. One recommendation that’s getting a lot of attention is from Zvi Brodie of Boston College and co-author of the new book, Risk Less and Prosper. Brodie’s strategy is to buy Treasury Inflation-Protected Securities (TIPS) to cover all your basic spending during retirement. You invest in assets other than TIPS only after ensuring the TIPS secure all your basic spending. There are pros and cons to the strategy, especially at the low yields TIPS offer today. Here’s a very good overview of Brodie’s strategy and some cautions about it. My belief is that at today’s yields the TIPS strategy is more risky than Brodie believes, but it’s a better strategy than some others, such as stocks for the long run and traditional diversified portfolios.

If you invest your retirement funds in stocks, on average you can expect the stocks to grow larger than the TIPS growth, but stocks are much more volatile and there is a decent chance that you may end up finding the portfolio value of your stocks to be insufficient to meet that $20,000 spending need.  This is the idea behind “risk less.”

Stocks surged in late 2011 and early 2012. It’s no surprise this occurred at a time when most economic data came in better than expected, positive surprises in analyst jargon. Recently, that trend reversed. Recently the Economic Surprise Index issued by Citigroup turned down and is decided negative. It’s still not at the levels reached in 2010 and 2011 at the market bottoms, but it’s definitely turned down and appears headed to a reading of zero. It was approaching 100 just a few weeks ago. It’s a sign that equity markets and economic optimism surged ahead of the economy since last fall.

We’ll start the day with a double dose of recent good news for those who’d like to be leaner and have better heart health without switching to rigid consumption restrictions. The first report is that eating chocolate regularly can make you leaner. A study concluded that people who ate chocolate five or more times per week were leaner than those who ate less chocolate. The bad news is the study leaves a lot of questions unanswered. It didn’t adjust for exercise or other parts of the diet. It also didn’t go into details about what types of chocolate were consumed or the quantity. But the bottom line for now still is good news for chocolate lovers.

The survey results suggest researchers looking at diet should consider the types, rather than number, of calories people are eating as foods such as cinnamon and chocolate are found to provide possible health benefits, said Golomb, an associate professor of family and preventive medicine at the university’s School of Medicine.

“Chocolate has already shown favorable associations to heart disease, all-cause mortality, blood pressure and even cavities,” she said “If you’re eating a couple of squares of chocolate a number of times a week, it’s probably just fine. Typically chocolate is consumed as a sweet and should have adverse applications for body mass index. In fact, it’s the converse,” according to the survey.

The other study concluded that men who already had a heart attack improved their heart health by having two alcoholic drinks daily more than those who had no drinks. The study joins others that found moderate drinking of about one drink per day enhances heart health.

The results, published today in the European Heart Journal, add to other studies that have observed the positive effects of moderate drinking. People who have one drink or fewer each day are 14 percent to 25 percent less likely to develop heart disease compared with those who don’t imbibe, Canadian researchers said last year. Until now, data on whether it can also help heart attack survivors have been limited and conflicting, according to Pai.

Don’t mistake leverage for genius. That’s an old saying in the investment business, but it’s especially true today. As Bill Gross of PIMCO says in his latest monthly essay, you could make money by leveraging almost any financial asset until 2008. While the period since then is described as a deleveraging, it really isn’t. Households in the U.S. and some other places are slowly reducing debt. But governments and central banks are balancing that with increased debt. Count it all up, and leverage is expanding but more slowly than before the crisis.

We’re now in a period of financial repression. Interest rates generally will be negative, and growth will be slow. Soon, a mild releveraging will begin, and that means rising rates and credit spreads. Gross says the question for investors today is make The Great Escape from this period of volatility and low returns, even negative real returns.

As well, financial assets cannot be elevated by zero based interest rate or other tried but now tired policy maneuvers that bring future wealth forward. Current prices in other words have squeezed all of the risk and interest rate premiums from future cash flows, and now financial markets are left with real growth, which itself experiences a slower new normal because of less financial leverage.

That is not to say that inflation cannot continue to elevate financial assets which can adjust to inflation over time – stocks being the prime example. They can, and there will be relative winners in this context, but the ability of an investor to earn returns well in excess of inflation or well in excess of nominal GDP is limited. Total return as a supercharged bond strategy is fading. Stocks with a 6.6% real Jeremy Siegel constant are fading. Levered hedge strategies based on spread and yield compression are fading. As we delever, it will be hard to deliver what you have been used to.

Gross suggests a narrow range of investment options going forward. (He emphasizes that you shouldn’t abandon PIMCO or its bond strategies.)

In plain speak –

For bond markets: favor higher quality, shorter duration and inflation protected assets.

For stocks: favor developing vs. developed. Favor shorter durations here too, which means consistent dividend paying as opposed to growth stocks.

For commodities: favor inflation sensitive, supply constrained products.

And for all asset categories, be wary of levered hedge strategies that promise double-digit returns that are difficult in a delevering world.

With regard to all of these broad asset categories, an investor in financial markets should not go too far on this defensive, as opposed to offensively oriented scenario. Unless you want to earn an inflation adjusted return of minus 2-3% as offered by Treasury bills, then you must take risk in some form. You must try to maximize risk adjusted carry – what we call “safe spread.”

Investors always want to know when to get out of a market before a top. For stocks, consider the level of margin debt. That’s the word from a technical analyst at Street.com, Helene Meisler. Margin debt on the S&P 500 is a short amount below the level is reached before the 2011 peak. It’s also not too far below the levels reached near the peaks of 2000-2001 and 2007-2008.

Margin Debt tends to rise as markets rise. While there is no magic number that rings a bell at the top, you can see from the chart below that in the last decade once Margin Debt gets over $300 billion we would have to consider we are no longer ‘early’ in a rally. It tends to put to bed the notion that folks are underinvested in the market.

Social Security isn’t a major problem. It can be fixed with a few tweaks, and the sooner changes are made the easier the tweaks will be. That doesn’t mean every American will have adequate retirement income, says Clive Crook of Bloomberg. Social Security doesn’t replace a lot of working years’ income for  most people, and too many Americans rely on Social Security for most of their retirement income. The investment markets also aren’t the major problem, though they aren’t helping. The fact is that Americans aren’t saving enough to generate retirement income security. Many people who’ve studied the issues agree. The difficulty is getting people to agree on what to do about it. The best thing you can do for your young adult children and your grandchildren is to encourage them to save 10% or more of their incomes starting as soon as they begin earning income.

Crook’s proposal is to supplement Social Security with a forced government savings program.

How, specifically, might this be done? I’d recommend, as a start, that an additional 5 percent be deducted from wages and invested in a choice of pooled accounts holding a mixture of domestic and foreign assets. Pooling and central administration would keep fees very low. Balances would accumulate tax-free until retirement; distributions would then be taxed. I’d also advocate that taxpayers provide a subsidy to those on low incomes, sufficient to cover the whole deduction for those earning the minimum wage, so that everybody could afford to save through their retirement account. To help meet the cost of this taxpayer subsidy, narrow the existing tax preferences for saving, which flow to those on higher incomes who least need the help.

The 30-year bull market in bonds, especially long-term treasuries, is nearing an end, says billionaire Wilbur Ross. He told CNBC that they are now the biggest risk in most portfolios. Ross believes that higher inflation is baked into the economy and that treasuries are a bubble at this point. He says he’d rather own equities than bonds at this point.

“I think the greatest bubble that is about to burst is the 10-year and longer Treasury, because the idea that inflation is gone forever and for all time, and therefore these artificially low rates can last, is silly,” the president of W.H. Ross & Co. said in an interview.